An index is a composite metric calculated by financial authorities such as exchanges, banks and rating companies to track the dynamics of a particular market’s capitalization. Because the index is purely a calculation, it cannot be purchased as an asset. However, it is possible to simulate an index using a few key tools.
Physical recreation
This method, although the most time-consuming and complex, involves the direct purchase of assets that match the index structure. Difficulties with diversification, liquidity issues, dividend accounting, rebalancing and transaction costs all come with this method.
Derivatives
There are many types of financial instruments based on indexes: such as futures, CFDs, options and swaps. While each has its pros and cons, they are most often used for short-term speculation rather than long-term investment.
Index funds
This is the most optimal method for passive investment strategies. There are many types of funds, such as mutual funds, ETFs and mutual funds, each with its own characteristics. By pooling funds from many investors into one pool, these funds can effectively recreate an index while minimizing costs. In some cases, funds may even invest through other funds to achieve their objectives.
ETF Features
The ETF structure requires additional attention, since it is one of the most preferred tools for creating passive investment portfolios. In an ETF, as in other mutual investment vehicles, funds are collected from various investors, each of whom owns a certain number of units or shares confirming their participation in the fund’s assets.