In 2002, China's first index fund was launched. After 20 years of development, index funds have gradually gained popularity among many investors. As of September 30, 2022, there were over 1,400 index funds in the market, with a total scale exceeding 2 trillion yuan (combining Class A and Class C shares, including ETF feeder funds).

Index funds select specific indices as their benchmarks, aiming to achieve returns similar to those of the tracked index. Therefore, to understand index funds and use them for investment, the first step is to comprehend the index they track.

How can one understand an index? It can be approached from three aspects: basic characteristics, risk-return characteristics, and valuation levels.

The basic characteristics of an index mainly include market capitalization features, sector composition, and key constituent stock traits. These features help investors preliminarily understand an index and analyze the differences between various indices.

Market capitalization features include the index's total market cap, market coverage, and the distribution of constituent stocks' market caps, which help investors gauge the index's representativeness and market cap style.

Taking the CSI 300 Index as an example, as of November 17, 2022, its total market cap was approximately 39 trillion yuan, accounting for nearly 50% of the total A-share market cap, making it a good reflection of the overall price movements in the A-share market. In terms of market cap distribution, 231 of the 300 constituent stocks had a market cap exceeding 50 billion yuan, with an average exceeding 120 billion yuan, indicating a large-cap style.

The sector composition of an index primarily refers to the industry distribution of its constituent stocks. Analyzing the key constituent stock traits involves identifying the heavyweight stocks that significantly influence the index's performance, their respective weights, and their combined weight. This helps investors better understand the index and distinguish between different indices.

For example, the Hang Seng Index and the Hang Seng China Enterprises Index are both representative indices of the Hong Kong stock market, with little difference in their market cap distribution. However, in terms of sector composition, as of October 17, 2022, the Hang Seng China Enterprises Index had a significantly higher proportion of "new economy" sectors such as information technology, consumer discretionary, telecommunications services, and healthcare compared to the Hang Seng Index. In terms of top 10 constituents, the Hang Seng China Enterprises Index includes companies like Tencent, China Construction Bank, Meituan, Alibaba, and JD.com, while the Hang Seng Index includes AIA, HSBC Holdings, Tencent, Alibaba, and Hong Kong Exchanges and Clearing, showing clear differences.