Indices went through a fashionable phase about 30 years ago. At one stage, they were the defining story for market analysts. As most investors know, market fashions don’t last, and the market’s enthusiasm for analytical tools tends to be endless until it’s discovered they don’t work. If you’re a trader, your information needs to be based on something very like Search Engine Optimization, a range of key facts. Indices have their place in the schematic, but not as the sole source of materials to make judgment calls.

The applications of indices- The positives

Indices do in fact have direct, useful applications. Ironically, their most obvious uses are much better leads than they look. The mere fact that an index moves up or down on a particular day doesn’t necessarily mean much, but the elements within it are often good indicators of trends. If you know how an index is weighted, you can pin down useful facts and find good information.

For example:

One glance at an index can tell you a lot. If the Aerospace index goes solidly up, it means that the heavyweights in that index are on the move. That in turn means new business, and new business for a company like Boeing is good news for related industries, localities and subcontractors and related manufacturers. It’s like a Yellow Pages of investment opportunities.

There are some market products like commodities and index based investments like mutuals and Exchange Traded Funds, which are obviously hardwired into their various indices. Their indices have direct dollar-based applications to these types of investments, and you can predict, fairly accurately, without even looking, sometimes, what’s happened, simply on the basis of the size of the index move. Again, if the Aerospace index takes a hit, you already know that Boeing or one of the other giants has tripped over something and things are looking very iffy.

So indices do tell pretty accurate stories, within these frames of reference. That is quite specifically not the case with a range of other scenarios, which are much more individualized and behavioral.

The negatives and the misleading scenarios

If indices are pretty faithful reflections of some types of information, they can be very misleading in some contexts:

• A boom market will keep telling traders they’re on a good thing in any index they look at, until the inevitable downward correction/disaster happens.
• Indices are weighted. Good stocks in dismal indices aren’t exactly unknown, and vice versa.
• Investment performance and ROI aren’t well defined by indices except in the specific hardwired investment types.
• Indices cannot track issues with their component companies very effectively, if at all.
• Nobody was aware of the scale or depth of the financial market fiasco in 2007. The indices were all pointing straight up, when the biggest downward correction since 1929 hit.
• An index can’t tell you if the semi-literate/amnesiac CEO of your investment is trying to replay the Enron saga or not with their capital management until it’s too late.  

Yes, indices matter, and yes, they can provide useful information, particularly if you’re experienced enough a trader to be skeptical on principle. Otherwise, stick to your SEO approach to key data and other information. It’s a lot safer.

Exchange Traded Funds have been so successful that the big financial groups are now getting interested. Deutsche Bank has opened up a range of ETFs on the DAX, and even the big mutuals are starting to try operating ETFs to provide more market exposure for themselves. This is partly because ETFs have become so popular that they’re pulling investment capital away from the traditional investment platforms. For SMSF investors, they’re gold.

ETFs deserve to be called “derivatives” in a sense few other financial products can claim. They’re based on hard equity values, to start with. They are literally derived from holdings, not variable earnings. That puts them several classes above other so-called investment vehicles, which are more like skateboards than any sort of “vehicle”. The lucky investors in the derivative junkyard skate along on nominal values until they have to come off.

ETFs have prospered because the equity and financial markets have outgrown the old investment products. They’re far more flexible than their 19^th century- based competitors, and they can target investment areas far more effectively. The average mutual or unit trust tends to be a generic product, with “growth” and other characteristics used as definitions of the nature of the investment. With ETFs you can invest across whole indices and classes of equity, quickly and efficiently, and trade them much more effectively.

There’s also a “class” factor in the ETFs. These are professionally managed funds, and the value of that was shown in the big 2008 crash. Some of the high unit value ETFs took a pounding, naturally, and weren’t helped much by the fact that the sudden loss of capital in the market reduced the high capital flow they needed. The lower unit value ETFs, however, were less affected as a group, and became day trader fodder, which was an interesting phenomenon in itself, because these traders are naturally very margin conscious.

Investors haven’t needed to hear much more than that to jump ship from the markets and head to more remunerative territory. That process has both identified a market for the major leaguers and left them with a problem: How to attract ETF investors?

Deutsche Bank is probably the best example of how the heavyweights are approaching the issue. The bank has had the good sense to use its name as a selling point, and being one of the world’s top banks isn’t exactly a turnoff for investors. The only real market resistance is coming from the fact that other ETFs are good investments. This is a highly competitive market, and getting investments away from the original ETF managers like Vanguard isn’t that easy.

If you’re doing DIY superannuation, you’ll be well aware of the spectacularly uninteresting options for investment available. Equity investments which produce demonstrated reliable ROI are thin on the ground, and those doing better than cash rates are comparatively rare.

Consider:

• ETFs are very easy to buy and sell.
• They don’t have the bells and whistles of mutuals, when you need to move money.
• They pay dividends, and do splits like stocks.

Check your options, because they may be exactly what you’re looking for.