Indexation

What is the purpose of indexing?

When managers measure the performance of their portfolio or their fund over a given period, it will always be compared to that of a benchmark. An index is a statistical tool designed to measure performance over time. Usually in the markets, a benchmark is a group of securities used to measure the performance of other stocks or securities in the market. It can be a stock index in the case of an equity portfolio, but also a rate benchmark in the case of a bond portfolio. 

ETFs  (Exchange-Traded Funds), which are financial products that make it possible to buy and sell baskets of stocks and bonds on the stock market in a single transaction, as if they were ordinary shares, sometimes have the sole mandate of indexing themselves as precisely as possible on a stock market index. Thus, index ETFs are investment funds that replicate the performance of a stock market index, such as the CAC 40 or the S&P 500, by faithfully following its performance. 

The fund manager will have to use cash products (he could buy all the stocks that make up the index and this is called physical replication) or derivatives (this is called synthetic replication) to recreate this performance.