- Indexed funds stand out for their goal of replicating stock indices, such as the S&P 500, with low fees and tax efficiency.
- Indexed funds are commonly integrated into asset managers’ portfolios, underscoring their role as key investment tools in the financial world.
- FlexFunds offers an asset securitization program to enhance the liquidity of investment strategies, including indexed funds. For more information, feel free to contact our experts.
Indexed funds, which have been around since the 1970s, are a type of financial instrument designed to replicate both the composition and performance of a specific stock market index—such as the U.S. S&P 500—typically with low management fees.
What is an indexed fund and what is its objective?
Unlike exchange-traded funds that trade on secondary markets, indexed funds are purchased through a managing entity at their net asset value, as explained by Spanish financial institution Santander.
In terms of structure, indexed funds involve investors contributing capital to the fund, while fund managers act as administrators, and a custodian institution takes on the responsibility of safeguarding the assets.
In these funds, managers don’t focus on selecting a basket of assets or crafting investment strategies to outperform the market. Instead, their role is to assemble the necessary components to match an index’s performance by investing in the same companies that make up the benchmark, explains FlexFunds, a firm specializing in exchange-traded products (ETPs).
FlexFunds provides solutions for fund managers by structuring independent investment vehicles, including the aforementioned exchange-traded products (ETPs).
Specifically, FlexFunds uses an asset securitization program to create ETPs representing various strategies. These may include indexed funds, REITs, private investment funds, or individual assets.
How is an index replicated?
It’s important to note that in indexed funds, managers are responsible for administering investor capital, which is then invested in the reference asset basket in an effort to mirror its performance at a low cost.
For example, an indexed fund based on the S&P 500 must include the 500 companies that comprise that index, with weightings proportional to each company’s market size. The same principle applies to funds tracking the Nasdaq 100, Dow Jones, and others.
Since indexed funds aim to generate returns through so-called passive management, they are generally considered easier to manage than other alternatives and offer high diversification through a single product that gives exposure to various asset classes.
How safe are indexed funds?
Like any type of investment, indexed funds are usually supervised and regulated by the relevant monetary authorities. Additionally, asset managers who oversee these funds must hold the proper accreditations to invest on behalf of the participants.
Even though they are relatively easy to understand and track through the general behavior of the index, experts recommend seeking professional advice to identify indexed investment funds in which one can invest, according to Spanish bank BBVA.
Meanwhile, Dutch financial institution ING notes that the main channels for accessing indexed funds include traditional banks, fund managers, or digital investment platforms that “connect to the wholesale fund market” and facilitate transactions for these assets.
Advantages of indexed funds
Over the past 15 years, indexed funds have grown globally from representing 10% to 21% of the total fund market. This growth is driven by three major advantages of these investment vehicles:
- Diversification: By allocating capital to a single fund, an investor or asset manager gains exposure to a portfolio composed of dozens, hundreds, or even thousands of financial assets. This improves overall portfolio diversification, which reduces volatility and decreases the risk of significant losses.
- Simplicity: They allow for the creation of comprehensive and diversified investment strategies in a straightforward way. As mentioned earlier, there’s no need to manage dozens of assets—just select a few well-chosen funds that track specific indices.
- Low costs: Being passively managed, they do not require heavy involvement from managers or investment analysts. Also, their management fees are typically lower than those of actively managed funds.
What risks are involved in indexed funds?
Because indexed funds are closely tied to index performance, they are not immune to market volatility. This means that during downturns, these investment vehicles may carry risks for those who opt for them.
Another consideration when choosing indexed funds relates to the investment horizon. They tend to yield better results over the long term and should be approached with realistic performance expectations. It’s important to remember that these funds are structured to track an index—not beat the market—and that associated costs such as management fees should also be factored in.
Passive investment strategies
Additionally, since indexed funds generally follow passive investment strategies, they typically do not react quickly to price declines in the components of the benchmark index.
And while fees are usually low as well, it’s important to keep in mind that they “also inherently detract from an investor’s total return,” according to a report from JP Morgan Wealth Management.
For these reasons, some of the key elements to evaluate when considering these instruments include analyzing the size of assets under management and how that may impact liquidity. Other important factors include the expertise of the index fund manager and the applicable fees.
Indexed funds stand out as a strong option within the wide range of investment vehicles, and they continue to be a mainstay in asset managers’ portfolios.
In this context, FlexFunds acts as a strategic partner for managers through the creation of ETPs. In fact, it enables the implementation of diversified investment strategies—including indexed fund strategies—as well as global distribution to end investors.
In summary, indexed funds are a type of financial instrument designed to replicate both the composition and performance of a given stock index. Asset managers choosing this vehicle can use securitization to reach a broader base of investors more efficiently than any other repackaging alternative currently available in the market.
To learn more about FlexFunds’ ETPs and its asset securitization program, don’t hesitate to contact our team of specialists. We’ll be happy to assist you!
Sources:
- https://www.bancosantander.es/en/faqs/particulares/ahorro-inversion/que-son-fondos-indexados
- https://www.bbva.com/es/salud-financiera/fondos-indexados-ventajas-tienen/
- https://www.ing.es/ennaranja/invertir-dinero/fondos-de-inversion/los-fondos-indexados-una-alternativa-interesante-inversion/
- https://www.chase.com/personal/investments/learning-and-insights/article/what-is-an-index-fund
- https://www.ici.org/system/files/2024-05/2024-factbook.pdf
