Pretend you’re an asset manager that’s decided to increase your commodities exposure. You don’t have the commodity picking experience to effectively deploy $500M so instead you call up your favorite commodities index salesperson. They show you some lovely indices, help you choose one, and charge you a small flat fee to maintain your index. For very little effort and cost, you’re now the proud owner of a complicated financial product that systematically manages a portfolio of commodities futures contracts.

Why are you going to a bank for a fund-like product? Indices belong to a family of products that have historically moved between sellside and buyside. While many of these trading strategies were originally developed at banks, the post-Volcker world saw these strategies transition into the realm of asset managers and hedge funds. However, with tightening margins and pullback from discretionary, investors now prefer cheap, transparent products over opaque funds. In the past five years, this distinction has become evident – banks own passive exposure and simple risk premia products that they can offer cheaply and at scale, whereas hedge funds own pure alpha risk premia products.

Index products at banks are often called systematic trading strategies because they strictly follow a predefined set of rules. If you want passive broad market exposure, you’d be understandably nervous if your index provider has too much discretionary power. For transparency and reproducibility reasons, the trading rules describe how the index behaves in all imaginable situations. That way, you can rest easy knowing that your index provider can’t go off the rails. Your job as the asset manager is to construct a portfolio of index products that the bank is responsible for calculating and maintaining.