Dow Jones, Parala Capital discuss forward looking indices

Allocation decisions could be different in future, according to Dow Jones Indexes and Parala Capital, which have jointly developed a method for making forward looking indices.

Dow Jones Indexes has taken a decisive step onto turf traditionally held by discretionary managers, establishing a benchmark based on forward-looking rankings provided by Parala Capital LLP, using macro-economic factors.

The index, Dow Jones Parala Global Sector Macro Allocation Index, differs in two significant ways from how traditional indices were historically constructed. First, it works off macro inputs from the experts at Parala, so it is not a bottom-up product, although it applies the inputs in a rules-based method.

Second, the macro inputs it uses have an element of prognosis for the 19 equity market sectors (Dow Jones sub-indices) it uses, so it does not run according to automated rebalancing of securities, in contrast to most equity indices.

Jamie Farmer (pictured), executive director at Dow Jones Indexes, explains that top-down analysis by Parala indicates which indices are expected to out- and underperform over the next three months.

The index is reviewed quarterly. Farmer says this “provides a global sector asset allocation strategy that has had consistent outperformance over the benchmark.”

Clash of index titans

On backtesting, the index beat the Dow Jones Sector Titans Composite Index in ten of the past 11 years, suggesting that the strategy does not depend on specific market or macro conditions to outperform.

“Parala’s research is a pioneering way of building an index from the top down. It asks, ‘What does the macro economic environment look like, and how do we build an allocation strategy taking that into account?’”

Farmer says the theory behind this index can be expanded to new products, to different equity sub-indices, commodities or currencies. Diversification limits are set so that products based off the initial index would be Ucits compliant.

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