Types of equity indices
1. Broad market indices represent as equity market in entirety. For e.g. Shanghai Stock Exchange Composite Index (SSE) is a market capitalization-weighted index of all the stocks that trade on Shanghai Stock Exchange.
2. Multi-market indices represent indices of different countries. The classification may be on geographical location, economic development status etc. For eg. MSCI World index, MSCI Emerging Market index etc.
a. Fundamental weighting has been used in multi-market indices to avoid countries with stock price appreciation getting over-represented. This is achieved by taking the ratio of market capitalization to a region’s GDP as a measure of weight rather than market capitalization alone.
3. Sector indices represent different sectors like banking, infrastructure, IT, transportation, oil, and gas etc. It helps investors gauge which sectors of the economy are doing better/worse at any given time. The sector indices can be for a particular country or a region.
4. Style indices represent securities on the basis of their market capitalization, growth, value or a combination of these characteristics. These indices help evaluate the performance of investment manager based on their investing styles.
a. Market capitalization indices classify securities as large cap, mid cap and small cap depending on the market capitalization of the securities.
b. Value or growth indices segregate stocks on valuation (low price to book multiple, high dividend yield) or the growth prospects of a security.
c. Market cap and value/growth indices use a permutation/combination of the above classifications. For e.g. large cap value, mid cap growth indices etc.
Check your concepts:
(46.10) The classification of securities based on their market capitalizations is most likely to be an example of which kind of equity indices?
(a) Multi-market indices
(b) Broad market indices
(c) Style indices
Solutions:
(46.10) Correct Answer is C: The classification of securities based on their market capitalizations is an example of market capitalization index and that is a part of style indices.
