Understanding Types of Equity Indexes | CFA Level I Equity Investments

1. Broad Equity Market Indexes

Broad equity market indexes represent an entire equity market, typically including stocks that make up over 90% of the selected market. For instance, the Wilshire 5000 Index, which consists of more than 6,000 US stocks, is a good representation of the overall performance of the U.S. equity market.

2. Multi-Market Indexes

Multi-market indexes comprise indexes from different countries, representing multiple stock markets. They can be based on geographic regions, economic development groups, or even the entire world. These indexes are crucial for investors with a global approach to equity investments.

Some index providers use a fundamental weighting approach, weighting stocks within each country by market capitalization and weighting each country in the overall index based on a fundamental metric, such as GDP proportion.

3. Sector Indexes

Sector indexes represent and track different economic sectors (e.g., consumer goods, energy, finance, health care, technology) on a national, regional, or global basis. Investors may use these indexes to overweight or underweight exposure to different sectors based on the economic cycle’s stage.

4. Style Indexes

Style indexes can be categorized according to market cap, value or growth, or a combination of these traits. They reflect the investing styles of investors like small-cap, growth, and value investors. Market-cap indexes can be differentiated into small cap, mid cap, and large cap stocks, while value and growth stocks can be differentiated based on price-to-earnings ratios or dividend yields.

Combining market-cap groups with value and growth classifications results in the following six basic style index categories:

• Small cap value
• Mid cap value
• Large cap value
• Small cap growth
• Mid cap growth
• Large cap growth

However, style indexes have some unique characteristics:

1. There’s no universal definition for classifications, so the same stock may appear in different style indexes.
2. Stocks can migrate from one style index category to another due to changes in valuation ratios and market cap, resulting in higher turnover for style indexes compared to broad market indexes.