What is a benchmark index, and how to read one properly
Every index fund is defined by its benchmark index. But an index is not simply "a list of companies": it is a calculation rule, and the details of that rule decide half your outcome. Here is what you actually need in order to read one.
What it is, exactly
A benchmark index is a theoretical portfolio defined by three things: what goes in (universe and selection criteria), how much each holding weighs (weighting) and when it is reviewed (rebalancing). No more, no less.
It does not exist physically: nobody "buys the MSCI World". What you buy is a fund that tries to reproduce that rule with real shares.
Who calculates them
Private companies that make their living licensing indices to fund providers: MSCI, FTSE Russell, S&P Dow Jones, Solactive, Bloomberg. They are not public bodies or neutral by decree: they decide which countries count as "developed", when a company enters or leaves, and they charge for it. Part of the TER you pay is that licence — which is why less famous index providers (Solactive, for instance) tend to make a fund cheaper.
The detail almost nobody explains: Price, Net and Gross Return
This is what separates reading an index from understanding one. The same index is published in three different versions:
| Version | What it includes | Typical use |
|---|---|---|
| Price Return (PR) | Price movement only. Ignores dividends. | The figure quoted in the news |
| Net Return (NR) | Price + dividends, less the withholding tax a foreign investor would bear. | The real benchmark of nearly every ETF |
| Gross Return (GR) | Price + full dividends, no withholding. | A theoretical, unreachable reference |
The gap is not cosmetic: in a global index, dividends contribute on the order of 2 percentage points a year. When you hear "the S&P 500 is up X%", you are almost always being given the Price Return version — the lowest of the three, and not the one your fund earns.
And the other way round: a fund boasting that it beat its index may be measuring against the Net Return version while collecting dividends slightly more efficiently. That is why the comparator always shows each product's exact index.
How the weight is split
- By market cap. The default: each company weighs what it is worth. It is what puts the US at around 70% of the MSCI World without anyone deciding it.
- Equal weight. Everything weighs the same. It gives smaller names more room and forces frequent rebalancing, which makes the fund dearer.
- By factor. Weight depends on a measured characteristic: value, quality, momentum, low volatility.
- By fundamentals or dividend. Weighted by earnings, sales or dividend yield instead of size.
Read the index before the name: every factsheet in the catalog states exactly which index the fund tracks. Two funds that look identical can follow different indices — line them up in the comparator.
Tracking an index is not copying it
No fund replicates its index perfectly, and the two measures that quantify this get confused constantly:
- Tracking difference: how far the fund landed below or above the index over a period. This is the one that hits your pocket.
- Tracking error: how much that difference varies. It measures consistency, not outcome.
A fund can have a 0.07% TER and still land 0.15% below its index through weaker replication or less efficient dividend taxation. What matters is what you end up with, not what the cost sheet says — which is why our ranking of the cheapest index funds warns that the TER does not tell the whole story.
In short
- An index is a rule: what goes in, how much it weighs, when it is reviewed.
- Private companies calculate them and charge a licence, which sits inside the TER.
- The Net Return version is what nearly every ETF tracks; the one in the news is usually Price Return, about 2 points a year lower.
- Between the index and your fund sits tracking difference, which the TER does not show.
Educational content, not investment advice.