What Is a Composite?
A composite is a grouping of equities, indexes or other factors combined in a standardized way, which provides a useful statistical measure of overall market or sector performance over time. Investors also use the term "composite index." Composites are created for both investment analysis of economic trends and to forecast market activity.
A composite index has a large number of factors that are averaged together to form a statistic representative of an overall market or sector. As an example, the NASDAQ Composite index is a market capitalization-weighted grouping of approximately 3,000 common stocks listed on the NASDAQ stock exchange. These indexes are useful tools for measuring and tracking price level changes for an entire stock market or sector, and an index provides a useful benchmark against which to measure an investor's portfolio performance. The goal of a well-diversified portfolio is to outperform a particular index.
How an Index Is Managed
One popular index is the Dow Jones 65 Composite Average, which includes 65 companies that make up three other Dow Jones indexes. The goal of an index is to select stocks that represent a particular sector or market, and a committee decides which stocks to include in the index. Most indexes are weighted by market capitalization, which refers to the total dollar amount of stock a particular firm has outstanding. A company with a large capitalization makes up a larger percentage of the total value of the index and has a bigger impact on the performance of the index. Using this approach means that companies with a smaller capitalization have less impact on the index. In addition to stocks, the financial industry provides indexes for bonds and currency exchange rates.
Factoring in Economic Indexes
Economists monitor a variety of indexes to forecast economic activity. The Index of Leading Economic Indicators, for example, is an index of other indexes. This index is a monthly report composed of 10 economic indexes including new orders for capital goods and new building permits for residential buildings. These leading indicators tend to change before movements in the overall economy.
Examples of Benchmarks
An index is used as a benchmark to measure the performance of a portfolio manager for a mutual fund or an exchange-traded fund. A portfolio of large capitalization stocks, for example, uses the Standard & Poor’s 500 Index as a benchmark. Financials sites, such as Morningstar, compare the performance of the fund to the benchmark and also compare the fund’s results with other funds that use the same benchmark. All of these data are used to assess the fund manager’s performance.