Strategy-based indexes could be the next wave of product development in the indexing world, Dow Jones Indexes’ John Prestbo told IndexUniverse.com Managing Editor Olivier Ludwig at IndexUniverse’s first-ever “Inside Indexing” conference taking place in Philadelphia this week.

Even though the increasingly intricate index construction methodologies are more expensive than plain-vanilla cap-weighted indexing strategies, Prestbo, editor and executive director at Dow Jones Indexes, argues there’s room at the table for everyone, and that in the imperfect world we inhabit, indexing “nirvana” really doesn’t exist.

Ludwig: What are your thoughts about the expansion of indexing, generally?

Prestbo: I think it’s a very good thing. The indexing way of investing certainly is the low-cost way, although we now have some indexed products out there with, shall we say, “moderate” fees, not low fees.

Ludwig: Like the commodities-exposure schemes?

Prestbo: Yes, and some of the strategy indexes and those involving emerging markets, because those really are higher-cost venues for trading.

Ludwig: Is cost the main caveat that you have, or is indexing going off the rails? I can hear John Bogle raising strong objections here. Are you in that school, or are you very open to pushing the frontiers of what is indexable?

Prestbo: I think Jack Bogle has a very good point. For many people, broad-based indexing is the way to go. They get their exposure, they pay very little for it and they ride the markets. I think that makes sense for a lot of people.

But there are a lot more people who want to take a more hands-on approach and yet they don’t want to subcontract to an active advisor or active portfolio manager. So, for those people, we’ve all been creating indexes that go beyond the original plain-vanilla variety.

Ludwig: What are we talking about here? Things like what Rob Arnott’s up to, or to those smart-beta indexes that have proliferated in the last 12 months?

Prestbo: That’s exactly what I’m talking about. I group them all together into a broad category called “strategy indexes,” where the index is not tracking a traditional segment of the market so much as it’s tracking a way of approaching the market. A lot of people want to get the best return they can, and they are willing to put in the time and effort to be flexible and manipulate their portfolio among various offerings. They combine the benefits of semi-active investing with the lower costs that come with it. The cost may be higher than the plain-vanilla indexes, but they are lower than an active manager.

Ludwig: What do you make of Matt Hougan’s and Dave Nadig’s comments yesterday about indexes? Under a microscope, all these indexes start to look subjective and perhaps fallible. Is there a future in indexing where these gaps will be bridged, where these complaints won’t be as apparent?

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