Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 585

The abacus, big data and a brief history of indexing

When Charles Dow, a journalist, developed the Dow Jones Industrial Index in 1896, the abacus was still widely used to make calculations. Arithometers, which were invented by Charles Xavier Thomas de Colmar in 1820 and in commercial production by 1851, were also a common sight.


Source: arithmometre.org

Commercial production of the arithmometer ended around 1915 and abacuses are largely confined to primary schools these days. Meanwhile, the Dow Jones Index is still widely quoted. Let's start by looking at how it is constructed. 

The Dow Jones is a (share) price-weighted index, which means that the stocks with the highest price have the largest weighting. This would have been the easiest way to create an index with the calculation tools available at the time.

Currently, UnitedHealth Group, which has a price of US$585 per share, has the highest weighting in the portfolio at 9.6%. By contrast, Apple is roughly six times larger than UnitedHealth in terms of market cap yet only makes up 3.5% of the Dow Jones.

The Dow Jones provides a general barometer of US equity performance. But it does not make any sense from an investment perspective because a share price could be a function of having fewer (or more) shares on issue. A share price, by itself, is not useful for making investment decisions.

After World War I and the next type of indices

At the turn of the 20th century, new mechanical calculators were usurping the arithmometer as the calculator technology of choice. The comptometer, the Burroughs adding machine and Odhner’s arithmometer became the calculators of choice.

Indices evolved as they were able to embody more complex calculations. The next major innovation was ‘market capitalisation’, which was pioneered by Henry Varnum Poor and the Standard Statistics Co.

The result was the 1926 predecessor of the United States’ S&P 500. A market capitalisation index uses the size of a company for inclusion. Therefore, in a market capitalisation index, the larger companies have bigger weights. In the S&P 500, Apple makes up around 6.7% and UnitedHealth around 1.2%.

Market capitalisation indices were considered better barometers of the market, so became the source of data quoted in finance news. Again though, the index was intended to be a market barometer, not a tool for investment.

In the 1950s, research by Harry Markowitz and William Sharpe supported market capitalisation indices as an investment tool. This is the Theory of Efficient Markets. Based on this theory, market capitalisation-weighted indices deliver the best returns for the least risk. It was thought that you cannot outperform the market unless you take on additional risk.

But there are numerous examples where the market has been wrong. There have been periods of irrational buying and selling and there have been periods during which bubbles have formed.

Consider too, the differing needs of individual investors and institutions. Each has a unique reason for buying and selling shares and could assign a different value to different aspects of the financial transaction which is often unrelated to the valuation. For example, investors sometimes trade for tax, income or even emotional reasons. As a result of these factors, the market is not efficient in reality.

By the 1970s, professional fund managers were aiming to exploit these inefficiencies, targeting returns above market capitalisation indices.

Computers, ‘big data’ and the next wave of indices

By now IBM had created mainframes, and the desktop computer was becoming a reality. The first handheld programable calculator, the HP-65 was released in 1974 at US$795 (Nearly US$5,000 in today’s dollars).

Computers and calculators were getting faster, smaller and cheaper. Savvy active fund managers were able to use some of this technology to their advantage.

An active fund manager proactively makes decisions over which investments are bought or sold, generally with the aim of outperforming a market index. This is done via a mix of qualitative and quantitative research, personal judgement and forecasting, so computing technology and its implementation could be a competitive advantage.

When actively managed funds were first offered to investors, performance was uncertain, and the costs were high. Sometimes the returns were good, but often they were not. Many people found this a poor bargain, so preferred lower-cost passive funds which tracked market capitalisation indices. In these passive funds, returns were not high, not low, just the market average. The rise of ETFs this century has largely been driven by demand for these passive funds.

At this stage, passive funds only tracked market capitalisation indices. However, sophisticated investors in passive funds started to consider the possibility that alternate index weightings, different from market capitalisation, could give investors higher returns for the same, or even lower levels of risk.

Alternate index construction methods started to focus on grouping companies with common valuation characteristics, common balance sheet qualities and common fundamentals to screen or weight stocks, including equal weighting constituents.

These innovative index construction techniques became known as ‘smart beta’. They are ‘smarter’ because they take a more considered approach to what goes into the index, other than just the size of the company.

These index innovations have been driven by a combination of investors seeking investment outcomes beyond benchmarks and the advent of technologies like ‘big data’ that enabled financial professionals to better leverage the data in financial reports, performance data points and mathematical algorithms to target these outcomes.

Unlike market capitalisation indices, these ‘smarter’ indices are created with an investment outcome in mind and were not created initially to represent the performance or health of the share market.

We like to say smart beta combines the best of active and passive investing: having the potential for better investment outcomes while being rules-based, transparent and cost-efficient.

 

Arian Neiron is CEO and Managing Director - Asia Pacific at VanEck, a sponsor of Firstlinks. This is general information only and does not take into account any person’s financial objectives, situation or needs. Investors should do their research and talk to a financial adviser about which products best suit their individual needs and investment objectives.

For more articles and papers from VanEck, click here.

 

 

RELATED ARTICLES

There's nothing sleepy about Rip Van Winkle indexing

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Latest Updates

Taxation

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook for residential real estate.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.