Allocation to Alternative Indexes on the Rise

April 26, 2013 ( – A study from Northern Trust found that more institutional investors are considering allocation to alternative indexes for beta management.

Northern Trust released a white paper, “The New Active Decision in Beta Management,” based on its survey of 51 institutional investors, representing $800 billion in assets under management. The paper profiles how early adopters of the allocation to alternative indexes are using the approach.

Last year, Northern Trust examined the changes to passive and active management strategies, and the rise of customized beta strategies. This year, the company reports institutional investors are increasingly considering the full range of active and passive strategies available.

The majority of survey respondents said they were drawn to alternative indexes to reduce risk through these exposures (92.3%) and for diversification (84.6%). More than half (54%) reported interest in this approach to seek excess return.

Three in 10 institutions surveyed have an existing allocation to alternative indexes, and another 32% are considering using them. Of those using alternative indexes, six in 10 have increased their allocation over the past two years.

“Rather than viewing their investment strategy options as either active or passive, investors today are considering a continuum of options within beta solutions, with traditional market cap-weighted indexes on one end and fully active strategies on the other,” said John Krieg, managing director of asset management, Europe, Middle East and Africa region for Northern Trust.

There are challenges for investors considering alternative indexes, however, including their complexity and limited track records. Still, Northern Trust predicts these allocations will grow as understanding of their benchmarks improves. According to Mamadou-Abou Sarr, senior product specialist for global index management at Northern Trust: “While the investment is passive, we believe the decision is active and encompasses four steps.”

Investors must first define their objectives, then work with their managers to identify the factors that will facilitate these goals. Northern Trust then advises determining the combination and weighting of those factors before, finally, implementing the allocation and defining the monitoring criteria.

“Deciding to invest in an alternative index, and against which index to invest, needs to be considered in a similar vein to an investor’s active investment allocation decision,” said Chad Rakvin, managing director of global index equity at Northern Trust. The majority (60%) of survey responders agreed, and said their decision to allocate to alternative indexes was similar to an active decision and required due diligence. Half said the decision fell to their company’s active investment team, and less than 10% said their index team chose this allocation strategy. Seventy percent said funding for the alternative index allocation would come primarily from assets invested in active strategies.

“In order to reap the benefits of alternative indexes,” advised Bo Kratz, managing director for asset management, Asia-Pacific, Northern Trust, “investors need to ensure their allocations are truly aligned to their objectives and treat their allocation in the same way they would an active decision.”

The white paper and short video interviews are available for download at


Sara Kelly