Over the last half-century, index investing has revolutionized the financial industry. Initially focused on tracking market-capitalization-weighted benchmarks, recent technological advancements and increased demands for customization have spurred the development of innovative index-based products such as smart beta ETFs and direct indexing. This evolution has, however, also brought confusion around what constitutes index investing.

Investing has traditionally been divided into “active” and “passive” management strategies. For many years, index investing involved replicating market-capitalization-weighted benchmarks without actively selecting investments or deviating from market-cap weights (historically called “passive management”). In contrast, newer index-based strategies such as smart beta ETFs and direct indexing introduce active decision making in portfolio construction, challenging traditional distinctions.

To address this complexity, our report “Smart Beta, Direct Indexing, and Index-Based Investment Strategies: A Framework” proposes a new approach for understanding index-based strategies. This framework categorizes index strategies by the degree of active management they incorporate beyond traditional market-cap weighting. By doing so, it provides clarity on how these products fit into an updated spectrum of active management solutions.

In the next 5–10 years, increasingly diverging worlds—in which deglobalization, geopolitical conflict, inequality, demographic disruptions, and technological innovation contribute to increasingly distinct and divided perspectives as targeted content and personalization create alternate realities—and digital transformation are both expected to significantly shape the investment industry, according to a 2023 CFA Institute report, “The Future State of the Investment Industry.” These factors are generating demand for personalized investment products such as direct indexing, which allows maximal customization of portfolios. Simultaneously, smart beta and other ETFs with alternative weighting methodologies are gaining popularity for their rules-based approaches and ability to provide efficient exposures to different factors and investment themes.

Our report emphasizes the importance of establishing a clear indexing framework and enhancing transparency in the investment industry. By doing so, it aims to foster a deeper understanding of index investing among investors, firms, and policymakers, thereby supporting informed investment decision making.

For investment professionals, understanding these products is crucial in order to successfully meet investor preference. Policymakers also face challenges in establishing effective regulations, necessitating clear guidelines on disclosure and terminology to aid investors in evaluating and comparing different index-based offerings.

The report offers recommendations for investment firms and policymakers to enhance transparency, clarity, and investor understanding in index-based investments.