An index is a statistical measure that tracks the performance of a specific group of assets, such as stocks or bonds, to represent a particular segment of the global financial market.
Understanding financial indices
An index takes a theoretical portfolio of assets and calculates a single number to represent their collective value changes over time. Investors use this number to gauge market movements without having to track every individual asset. Indices exist for various asset classes and regions globally. The FTSE 100 tracks the largest companies on the London Stock Exchange, while the Nikkei 225 tracks selected companies in Japan.
The calculation of an index depends on its weighting methodology. Most major indices are market-capitalization weighted. In this structure, larger companies have a proportionately larger impact on the index price. Other indices are price-weighted, where assets with higher absolute share prices affect the index more, regardless of the total size of the company. Equal-weighted indices give every constituent the exact same mathematical influence over the final number.
Because an index is a mathematical construct, it is impossible to buy or sell an index directly. Financial institutions create mutual funds and exchange-traded funds that hold the exact components of a specific index. These funds allow investors to replicate the performance of the index in their own portfolios. Elephants looking to diversify their holdings often purchase these index funds to gain broad market exposure instead of selecting individual stocks.
Example
The Global Pachyderm 50 Index tracks the top 50 publicly traded companies involved in the agricultural supply of peanuts and the manufacturing of heavy-duty veterinary equipment across Africa and Asia. If a major drought affects peanut yields, the stock prices of the peanut suppliers in the index will drop. Even if the veterinary equipment companies report stable earnings during this period, the overall value of the Global Pachyderm 50 Index declines due to the poor performance of the agricultural components. This mechanism allows Elephants tracking the index to see that the broader pachyderm-related economy is experiencing a downturn without checking the stock price of each individual peanut farm.