Coming Soon to a Dictionary Near You

It may have been 30 years ago, in the early days of stock index futures, that the verb “equitize” (and its cognate noun, “equitization“) came into relatively common use.  The term, if Dr. Johnson will forgive me, meant “to provide equity returns without purchasing equity securities.”  Typically this was accomplished by buying S&P 500 futures — if I had a $10 million cash position, I could “equitize” it  by buying S&P 500 futures with a notional value of $10 million.  Unless I’d made a severe arithmetic error, the total return of my cash + futures position would very closely approximate that of a $10 million S&P 500 index fund; hence my cash had been equitized.

For unknown reasons, “bonditize” or “bondize” never caught on.

I propose that indicize (and its noun form, indicization) will sooner or later find their way into common use.  To offer an inelegant definition, indicize means to provide, in passive form, a strategy formerly available only via active management.  Consider, e.g., a hypothetical investor who wants to tilt her portfolio toward small-cap growth stocks.  Thirty years ago, her only option was to buy a mutual fund whose manager avowed a specialization in small-cap growth, and then to hope for three things:

  1. That the manager shared the investor’s definition of small-cap growth
  2. That the manager didn’t change his mind (for instance, by deciding that large-cap value offerered better opportunities this quarter) during the investor’s holding period
  3. Most importantly, that the manager’s stock selection ability, if not positive, was at least not so negative that it overcame the putative benefits of being in small-cap growth in the first place.

Since then, of course, advances in passive management mean that a strategy like small-cap growth is easy to indicize.  (Today our hypothethical investor’s main problem would be to decide which of several ETFs or mutual funds specializing in small-cap growth she’d prefer to buy.)  There’s no need to expose herself to the vagaries of active management when a passive solution can provide efficient and inexpensive exposure to the factors about which she really cares.  And of course indicization isn’t limited to size and style portfolios, but extends to other themes — low volatility comes immediately to mind — as well.

This makes the active manager’s life harder.  In former days, he could expect to be paid both for providing access to factor exposures as well as for stock selection; today, he’s increasingly limited to stock selection as factor exposure is indicized.  For the same reason, indicization is an unambiguous benefit for the investor.

 

The posts on this blog are opinions, not advice. Please read our disclaimers.

One thought on “Coming Soon to a Dictionary Near You

  1. Pingback: Low Dispersion Implies Low Value Added | S&P Dow Jones Indices

Leave a Comment

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>