The CFA Institute Research and Policy Center, the global association of investment professionals, has unveiled a new classification framework aimed at enhancing transparency and investor understanding of smart-beta, direct indexing and index-based investment products.

The initiative includes policy recommendations for regulators and firms to improve communication about these increasingly complex investment strategies.

This framework is built on three dimensions: strategy, sources of returns, and level of discretion, aiming to increase transparency and clarity for investors. The framework offers investment firms a tool to better communicate the nature of index-based products to clients. It classifies index-based strategies according to their level of active decision-making, moving beyond the traditional market capitalisation weighting approach.

The policy recommendations accompanying the framework emphasise the importance of clear disclosures regarding the active decisions involved in index-based products. The goal is to help investors understand the nuances and complexities of these strategies, which have evolved significantly from the simple active vs. passive dichotomy.

Rhodri Preece, CFA, senior head of research at the CFA Institute, said: “The notion of a simple bifurcation between active and passive investment products is outdated. Index-based strategies are varied in their design features and involve different layers of active decision-making, dispelling the historical distinction between active and passive management. This new framework intends to support investment advisers and end-investors through clearer disclosure and communication of the key features of index-based products.”

The research recommends that investment firms take specific actions to enhance client disclosures. These include educating and informing investors about the active decisions involved in index-based investments, clearly communicating the decision-making processes behind index fund creation, including security selection and weighting methodologies, and providing prospective clients with detailed information on index product features as part of pre-sale literature.