Index Investment – The newest trend in financial management

2016/01/27 08:00

The trend of index investment has taken financial markets by storm. It is widely accepted that financial management is essential to maintaining quality of life. However, investors in Taiwan are familiar with active investment, either by selecting stocks independently or by purchasing actively-managed, open-ended funds through channels like banks or insurance companies. Active investment comes non-systematic risks like errors in human judgment. These risks are eliminated in index investment, which has already been embraced by the mandates of large, long-term pension funds in Taiwan and abroad. For example, the percentage of index investment within the mandate of the Japanese National Pension, the largest pension fund in the world, has reached 80%.

With the growing market for index investment, professional index companies have been established in most international securities markets to more efficiently promote index investment and make a significant contribution to links between international markets. Michael Lin, Chairman of Taiwan Index Plus Corporation (TIP) stated that the concept of passive investment concept has become more widely accepted. With strong support from the competent authority, Taiwan Index Plus Corporation was officially established on January 27, 2016. TIP will be Taiwan's first professional index and information services company dedicated to satisfying investors’needs for index investment in Taiwan and providing investors with high-quality and comprehensive services. TIP will build on the TWSE's experience, expertise, and technical resources in index services and information services to develop various types of indices. By providing a wide range of index services, information services, and innovative products for Taiwan's capital markets, TIP will promote international connection and cooperation between Taiwan and global markets, stimulating the development of Taiwan’s capital market on multiple levels and through multiple products.

Index investing minimizes the risk of human error and prevents against fraud by fund manager. Recent scandals involving pension fund mandates or open-ended funds all come from the gray area of active management, where unscrupulous fund managers may derive profits from their decisions on a trade's transaction target, time and amount. With index investment, managers are required to purchase a certain amount of constituent stocks within a specific timeframe based on the constituent stocks and weighting of the underlying index. This prevents against fraud and lowers the costs of investment. The greatest advantage of index investment is that it saves time and energy for investors. In the past, investors spent a lot of time and energy studying individual stocks, often making the age-old mistake of buying high and selling low. It is far better for investors to select passive investment, determine in advance their asset allocation, market entry, and take profit strategies, monitor investment performance on a regular basis, and take profits at exit points.

Eugene Fama, American economist and the winner of the 2013 Nobel Memorial Prize in Economic Sciences indicates that, based on his research and experience of the market, stock prices immediately reflect accessible information, making it difficult for investors to obtain excess returns. In the real world of investment, most people cannot defeat market performance. Thus, this Nobel winner's investment advice is to select index investment, which reflects market performance, allowing investors to easily reap better-than-market returns. Taiwan's Labor Pension Fund also takes advantage of index investment, with about 40% of the fund adopting index investment, a stable investment strategy with sounde returns. Furthermore, half of overseas investment by all major pension funds is dedicated to index products. In the future, Taiwan Index Plus Corporation hopes to develop various niche indices, providing investors with a multitude of options in index investment for comprehensive asset allocation, sound investment, and steady profits.