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

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

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.