CFA Institute's new framework aims to improve clarity for index investment products

Active decisions made by asset managers in the creation and maintenance of index-based products should be clear to investors. And the CFA Institute has developed a framework to help.

With innovations such as smart beta ETFs and direct indexing, the investment classification framework and policy recommendations for regulators and firms are designed to improve transparency, communication, and investor comprehension.

Under the framework, index-based strategies are explained to investors according to their level of active decision-making and indexing is on a spectrum beyond traditional market cap weighting, based on three dimensions of strategy, sources of returns, and level of discretion.

Rhodri Preece, CFA, senior head of research, CFA Institute, said that the notion of a simple bifurcation between active and passive investment products is outdated.  

“Index-based strategies are varied in their design features and involve different layers of active decision-making, dispelling the historical distinction between active and passive management,” he said. “As index-based products have proliferated, incorporating more complex features than market capitalization weighting, there is a need for greater transparency and improved investor comprehension of these strategies. This new framework intends to support investment advisers and end-investors through clearer disclosure and communication of the key features of index-based products.”

With improving disclosures for investors as a focus, the recommendations for investment firms include:

• Educate and inform investors of the active decisions made throughout the investment process for index-based investments.
• Communicate to investors about the decision-making processes involved in index fund creation, including security selection and weighting methodologies used in the creation of the investment product or strategy.
• Provide prospective clients with access to more detailed information on index product features as part of the pre-sale product literature.

The framework and recommendations are available on the CFA Institute website.