New “enhanced” exchange traded funds could gain wider acceptance, especially among institutional investors, as the Financial Industry Regulatory Authority allows fund sponsors to provide backtested performance data on new benchmark indices.
“We think it is a critical development for ETF sponsors that already manage or plan to launch enhanced index ETFs,” writes Larry Petrone, principal and director of research at kasina, in an op-ed for Ignites. “Specifically, it gives firms offering enhanced-indexed ETF products the ammunition to assertively demonstrate their value to investors. That should significantly bolster their sales efforts with financial advisors.”
Backtesting allows fund providers to apply a new index’s methodology to market data to extract a theoretical historical performance.
FINRA recently lifted its restriction on backtested performance data on newly created benchmark indices in what it calls “pre-inception index performance.” However, sponsors can only provide the data to institutional investors and intermediaries. [ETF Sponsors Can Provide Backtested Data to Institutional Investors]
“[The data] can demonstrate how the ETF responds to broad market trends and changes,” Petrone writes. “For institutional investors, that is obviously important for new ETFs or ones with a history of just a few years.”
Consequently, the backtested data would allow ETF providers to better describe potential benefits and demonstrate the potential impact on an investment portfolio.
Nevertheless, potential investors should still treat the data points with a measure of caution as historical references are not a perfect indicator of future performance. [Is ETF Backtested Data a Reliable Indicator?]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.