Equal weight index funds

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adtx75001
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Equal weight index funds

Post by adtx75001 » Sat Jan 30, 2016 9:25 pm

Reading that possibly equal weight beats cap weighted. Any opinions? Does vanguard offer them?

longinvest
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Re: Equal weight index funds

Post by longinvest » Sat Jan 30, 2016 10:44 pm

First, there's an entry about Equal weighted indices in our wiki: https://www.bogleheads.org/wiki/Equal_weighted_indices

Second, instead of repeating previous discussions on the matter, I'll cite an October 2015 post by Advisory Board member Nisiprius:

Why is Apple so heavy in VTSAX?
nisiprius wrote:Equal weighting is grotesquely illogical. I don't see how it is that people don't see it.

Let's say it is 1982 and AT&T splits up. Bing! One stock ticker symbol becomes seven. If you are cap-weighting, almost nothing happens. The shares of AT&T are automatically exchanged, cap-weighted, for about the same dollar value of shares in seven different companies. You have about the same amount invested in the seven baby Bells as you previously did in AT&T. (Believe it or not I actually owned AT&T and that's what actually happened).

But if you are equal weighting, when AT&T splits you now have seven companies and you need to go out and buy seven times the dollar value in baby Bells as you formerly held in AT&T. (Talk about potential problems with front-running the index!)
Third, cap-weighted is how the market is. Why would market returns be insufficient to reach one's financial objectives? Why seek to beat the market? Beating the market is a negative-sum game, after fees (see: proof). It is best not to enter this game, as it is easy to end up on the losing side.

A recommended approach is to accept market returns and simply save more, by living below one's means. The market will return what it will return; we don't know how much. But, we do control how much we save and invest.

Here's a good starting point to learn more: wiki: Getting started
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Re: Equal weight index funds

Post by lack_ey » Sat Jan 30, 2016 10:58 pm

To add to that, equal weighting is costlier to maintain, requiring more transactions. It effectively shifts towards smaller stocks and value stocks, usually increasing the volatility and over many periods (but not many others) the return.

There is basically no economic rationale to equal weight, but it's one of the simplest alternative weighting schemes out there. If you suppose in general that stocks tend to be mispriced to some degree on a relative basis compared to what they should be trading at (some too high, some too low), one weakness of market cap weighting is that it gives a higher relative weighting (relative to underlying fundamental value) to overpriced stocks and a lower relative weighting to underpriced stocks. Non-market cap weighting schemes like equal weighting are less affected by this issue, if you believe it exists.

No, Vanguard does not offer any of these. The cheapest equal-weighted options have higher expense ratios than the market cap-weighted funds, and keep in mind that additional costs internal to the fund from greater trading are not reflected in expense ratios.

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adtx75001
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Re: Equal weight index funds

Post by adtx75001 » Sat Jan 30, 2016 11:00 pm

perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen. Expenses are higher yes but the returns seem to be worth it. But I'm not a professional of course

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Re: Equal weight index funds

Post by fortyofforty » Sat Jan 30, 2016 11:06 pm

adtx75001 wrote:perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen. Expenses are higher yes but the returns seem to be worth it. But I'm not a professional of course
I think the equal weighting would tend to overweight smaller, more risky stocks, and underweight larger stocks. Increasing risk can, over time, produce higher returns. Is there any information that you found on volatility of an equal weight index? Also, are you looking at equal weighting of the relatively large S&P 500 stocks, or much smaller ones?
Indexing works, not because of magic, but because of math. | Diligentia. Vis. Celeritas. - Jeff Cooper | Original Vanguard Diehard

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adtx75001
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Re: Equal weight index funds

Post by adtx75001 » Sat Jan 30, 2016 11:11 pm

All I'm wondering is there a better way to index. We all get so focused on tracking the S&P perhaps there is a better way to index that no one is talking about.

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Re: Equal weight index funds

Post by lack_ey » Sat Jan 30, 2016 11:18 pm

adtx75001 wrote:perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen. Expenses are higher yes but the returns seem to be worth it. But I'm not a professional of course
For the S&P 500, equal weighting would tilt towards the mid caps.

Since inception of RSP, if you just mixed an S&P 500 index fund with a mid cap index fund, you would have had better risk/return than using RSP (Guggenheim S&P 500 Equal Weight).
https://www.portfoliovisualizer.com/bac ... ount=10000

Other equal-weight funds exist but haven't done as well since inception in part because mid caps were relatively good over this stretch. Guggenheim's Russell 1000 Equal Weight (EWRI), Russell 2000 Equal Weight (EWRS), Russell MidCap Equal Weight (EWRM), and Russell Top 50 Mega Cap (XLG) recently changed indices, in part because of poor performance. Some of them also changed tickers.

Check a cap-weighted Russell 2000 fund (e.g. IWM) against EWRS since inception:
http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

Now, the equal-weight Russell 2000 fund's definition of "equal weight" was a bit weird... you can dig into the details if you really want. Point is, it's very period dependent and the boosters tend to emphasize RSP rather than the other funds because RSP did better than the S&P 500.

adtx75001 wrote:All I'm wondering is there a better way to index. We all get so focused on tracking the S&P perhaps there is a better way to index that no one is talking about.
A lot of people are focused on tracking the S&P [500] but I wouldn't say that "we all" are. Most people here prefer the total market index over the S&P 500.

In general, yes, there are slightly better ways of doing things than following an index, particularly when it comes to trading—you usually want to trade less and not at a predictable time that opportunistic frontrunners can exploit. There may or may not be issues with market cap weighting. But at least today, the alternatives are more effort and/or more expensive, probably not worth it.
Last edited by lack_ey on Sat Jan 30, 2016 11:24 pm, edited 1 time in total.

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Re: Equal weight index funds

Post by longinvest » Sat Jan 30, 2016 11:19 pm

adtx75001 wrote:perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen.
Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."

Bogleheads' Guide to Investing: "Using past performance to pick tomorrow's winning mutual funds is such a bad idea that the government requires a statement similar to this: "Past performance is no guarantee of future performance." Believe it!"
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adtx75001
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Re: Equal weight index funds

Post by adtx75001 » Sat Jan 30, 2016 11:24 pm

Good point i didnt think of that:) I love this site best thing ever:)

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Re: Equal weight index funds

Post by longinvest » Sat Jan 30, 2016 11:28 pm

adtx75001 wrote:All I'm wondering is there a better way to index. We all get so focused on tracking the S&P perhaps there is a better way to index that no one is talking about.
It is best to index using total-market index funds.

The following might help you: I highly recommend reading not only Taylor's post, but also the various documents his post links to. They contain a wealth of knowledge and wisdom.
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Re: Equal weight index funds

Post by timboktoo » Sat Jan 30, 2016 11:35 pm

adtx75001 wrote:perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen. Expenses are higher yes but the returns seem to be worth it. But I'm not a professional of course
One of the most important lessons to learn about investing is that historical returns are not indicative of future returns. It sounds like legalese for the longest time, especially if the thrill of an easy gamble is flowing through your veins. It's easy to ignore the words and not see the truth behind them.

Never pick one fund over another just because it has outperformed in the past. It's a good way to get returns below what the market is offering people who are willing to just sit still. The tendency for people who follow this approach is to continually shift their money from one fund to another, never really understanding what they're doing. About the only pieces of information most people glean from looking into their investments is a rolling 10 year performance chart and a Morningstar star rating, both of which are completely useless in terms of really understanding what a fund has to offer and why you should invest in it or run away.

There's always a reason why something outperformed another thing. With regard to equal-weighting strategies, they have a few things going for them:

1. They give a higher allocation to smaller companies, which are often capable of growing their revenue faster than a larger company is. Warren Buffet has spoken many times about how difficult it is to beat the market now that his company is the size it is, and he's arguably the greatest investor of our time.

2. There's a contrarian spirit to equal weighting that can work to its advantage when the market is wrong about the upside of a smaller company or the downside of a larger one. The risk is more evenly spread. If Apple greatly outperforms, us market cap indexers get to reap the rewards of that in a way that's greater than the equal-weighted people get to do. If Apple underperforms, the equal-weighted people get the advantage.

I am not against equal-weighting, though I don't do it personally. I hold a simple Three Fund Portfolio. Whatever strategy you choose, make sure you pay attention to taxes and expenses and stay the course. Control what you can control. Don't invest in RSP in a taxable account. It'll be less efficient than a broad market cap-weighted stock index fund would be. Taxes matter a lot when it comes to realized returns.

Good luck. Also, try searching the form for more on equal-weighting. It's been discussed multiple times here.

- Tim

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Re: Equal weight index funds

Post by printer » Sun Jan 31, 2016 2:36 am

"Beyond Cap Weight: The Empirical Evidence For a Diversified Beta"
By Rob Arnott, Vitali Kalesnik, Paul Moghtader and Craig Scholl
Journal of Indexes, January/February 2010

https://www.researchaffiliates.com/Prod ... d_Beta.pdf

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Re: Equal weight index funds

Post by nisiprius » Sun Jan 31, 2016 7:48 am

In my opinion, adtx75001, there are three big mistakes beginners make. They make them because (in my cynical opinion) people selling investments encourage them to make them. I'm going to list the three and then focus on the third.

1) Not understanding just how much results can vary depending on endpoints.

2) Not allowing for the fact that most people writing about investments are interested parties, and the "investment" industry has a vested interest in selling their products. In this particular case... Vanguard has an overwhelmingly dominant position in cap-weighted mutual funds, so many of Vanguard's competitors have a vested interest in convincing you that cap-weighted is the worst possible weighting and that anything but cap-weighting is better.

3) Concentrating on return, rather than on risk-adjusted return. This is extremely important, because it is easy to increase return by taking more risk. How much risk is right for you is perhaps the most important investing decision you need to make. But in comparing mutual funds you will be played for a sucker every time if you compare return without comparing risk.

The game plays itself out over and over and over again the same way. a) Lots of funds take more risk than the market as a whole... by placing concentrated bets in various ways. Lots of them lose, lots of them win. b) You get a selective view because the magazines, advisors, everybody is only interested in tell you about the ones that won. c) At any instant in time, the best-performing fund will not be an index fund, it will be some fund that took more risk that paid off.

Now, let's look specifically at RSP, the best-known equal-weighted S&P 500 ETF, and VFINX, the--no, let's not always use Vanguard, let's use Fidelity's S&P 500 index fund, just for a change (it doesn't actually matter one bit). There are lots of ways to measure risk and reward, and the best way is to figure out how you want to do it yourself. Whatever I do, boosters of equal weighting will say I was using the wrong measures. So be it.

Your first clue that maybe RSP isn't all that exciting is that Morningstar gives them the same star rating, four stars. (Yes, Vanguard's S&P 500 fund gets four stars, too). The star ratings are flawed because people want to believe they are predictive, and they aren't--but they are a very fair comparison of actual past performance, taking risk into account.

Image
Image

If RSP outperformed, why didn't get more stars? Because it didn't outperform when you take risk into account. RSP takes more risks because it invests more in the stocks of smaller companies. Before showing you some standard numbers for measuring risk and reward, let's look at a very simple measure of risk: how did RSP perform in 2008-2009?

Source
Image

These show total return, including reinvested dividends. If you'd invested $10,000 each into the two funds at the end of 2007, reinvesting dividends, then in March of 2009 your brokerage statement would show $4,761--a loss of 52%--in the S&P 500 fund, but only $4,444--a lost of 56%--in the equal-weight fund. It's not a huge difference, but RSP is definitely riskier.

An accepted standard way--and I don't want to get into the perennial debate on whether it's the best way--to measure risk is with standard deviation, and risk-adjusted reward with the Sharpe ratio. If you check, what you will find--you can get these numbers from Morningstar under the "Ratings and Risk" tab is this. (For some reason they aren't showing Sharpe ratios for FUSEX right now, so I'll just ask you to believe they will be very very close to that of the S&P 500 index itself):

Image
RSP: standard deviation 17.67%, return 7.93%, Sharpe ratio 0.46
S&P 500 (cap-weighted): standard deviation 15.06%, 7.31%, Sharpe ratio 0.47.

Do you see it? Yes, over the past ten years RSP DID have higher return than the regular cap-weighted S&P 500. But it also had higher volatility aka standard deviation aka "risk." And the Sharpe ratios are virtually identical, meaning that the higher performance of RSP is simply commensurate with the extra risk. Just as the Morningstar star ratings show.

Well, finally, suppose you say "OK, I get it that RSP isn't really any better, it's just compensation for extra risk, but I'm willing to take that risk to get the extra return, so shouldn't I use it?" Probably not. The most obvious approach is just to boost your stock allocation. If you are looking at, let's say, 50% Total Stock Indexand 50% Total Bond Market Index, and you want more risk and thus the possibility of higher return, the first question is to ask is: why would it be better to swap in RSP in place of Total Stock index? Why wouldn't it be just as good to keep Total Stock but goose the stock allocation up just a bit... to 55/45 or 60/40?

Now here is where the next layer of phonus balonus comes in. Yes, there are some people who believe that it is better to overweight midcaps and small caps instead of just increasing stock allocation. I don't do that, but those people might well be right. But even so: the reason why RSP has more risk and more return is, almost certainly, just because it puts more weight on mid-cap and small-cap stocks. But it does so in a sloppy and illogical way, and it charges you 0.40% in expense to do. Plus there are almost certainly big transaction costs on top of that because the amount of buying and selling needed to track an equal-weighted index is huge, while the transaction costs of tracking a cap-weighted index are small.

If you do want to overweight small-caps and mid-caps, then, almost certainly, rather than picking a sloppy fund that applies an irrational rule that happens to overweight them almost accidentally, you would be much better off studying up on "factor-based investing" or "slice and dice" and using some fund that intentionally focusses on small-caps, or small-cap value, rather than taking whatever the accident of equal weighting happens to give you. I do not personally do factor-based investing so I won't carry that line of exploration any further, beyond saying that if you want more risk and more reward than a traditional cap-weighted total market or S&P 500 index fund gives you, an equal-weighted S&P 500 fund is probably not the best way to go.

There's no great harm in it but you'd be allowing yourself to have been deceived in a small way into giving your money to Guggenheim instead of some other firm, because of the appeal of higher returns and failure to appreciate the reasons for those higher returns.
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Re: Equal weight index funds

Post by longinvest » Sun Jan 31, 2016 8:10 am

Bogleheads portfolios include both stocks and bonds (see the Bogleheads investment philosophy).

A better way to increase risk and potential returns is simply to increase the stock allocation within the portfolio, while still using total-market index funds. The advantages of doing so are many:
  • It is cheaper, because total-market index funds are almost always cheaper than other index funds.
  • More tax efficient, because total-market index funds have very low turnover.
  • It is simpler.
  • Changing the risk of the portfolio, as one advances in age and as the portfolio grows, simply involves increasing the allocation to bonds. There's no need to replace funds within the portfolio.
  • Lower risk of a significant index change, as the total market is what it is. Various total-market indices only have small differences. On the other hand, indices tracking only a part of the market (like small-cap stocks, or value stocks, or small-cap value stocks) do have significant differences in their composition, because nobody agrees on the definition of what is small, what is value, etc.
  • No front-running.
  • Easy to maintain.
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Re: Equal weight index funds

Post by SeeMoe » Sun Jan 31, 2016 6:31 pm

longinvest wrote:
adtx75001 wrote:perhaps I'm missing something but the returns long term seem to be much much higher in the equal weight fund. RSP soundly beats vfinx long term on every chart I've seen.
Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."

Bogleheads' Guide to Investing: "Using past performance to pick tomorrow's winning mutual funds is such a bad idea that the government requires a statement similar to this: "Past performance is no guarantee of future performance." Believe it!"
Like that old Bogle quote because it is timeless, right on the money free advice,..
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Re: Equal weight index funds

Post by in_reality » Sun Jan 31, 2016 7:18 pm

nisiprius wrote: 2) Not allowing for the fact that most people writing about investments are interested parties, and the "investment" industry has a vested interest in selling their products. In this particular case... Vanguard has an overwhelmingly dominant position in cap-weighted mutual funds, so many of Vanguard's competitors have a vested interest in convincing you that cap-weighted is the worst possible weighting and that anything but cap-weighting is better.
Why does Vanguard offer non-cap weighted funds? Because they need an alternative product to compete with Vanguard who has the overwhelmingly dominant position??? Um...
The Vanguard Global Value Factor UCITS ETF (VVAL) aims to capture the potential premiums of low-valued stocks, which are stocks that look inexpensive compared with the company’s fundamentals. This is achieved by favouring equity securities that, when compared to other securities in the investment universe, have lower prices relative to their fundamental measures of value (e.g. price-to-book or price-to-earnings ratio, estimated future earnings and operating cash flow).

The Vanguard Global Momentum Factor UCITS ETF (VMOM) aims to capture the momentum premium through focusing on stocks with strong recent share price performance, typically over the previous twelve months. Such stocks have been found to continue to outperform over the subsequent short- to medium- term time periods.

The Vanguard Global Liquidity Factor UCITS ETF (VLIQ) aims to capture the liquidity premium by investing in stocks that are less frequently traded and could be a source of outperformance over the long-term. This is achieved by favouring equity securities that, when compared to other securities in the investment universe, have low trading volumes and other measures of trading liquidity, including lower trading share and dollar volumes, based on percentage turnover, and price impact

The Vanguard Global Minimum Volatility UCITS ETF (VMVL) aims to help investors reduce risk in their portfolios. Investing in a portfolio that targets a combination of stocks with lower volatility compared with the broader market allows investors to maintain exposure to equities with the potential for improving risk-adjusted returns.
Anyway, Minimum Volatility seems to be hot lately. That is troublesome because money will pour in, it'll look like an outperforming strategy, hit it's peak, and then future returns will be less. This is true of equal weighted and many other strategies.

So I think Nisiprius should have stopped at #1:
nisiprius wrote:1) Not understanding just how much results can vary depending on endpoints.
That really is about what you need to know. Don't invest on recent performance because as others do too, you will be buying high only to see disappointing future returns.

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Re: Equal weight index funds

Post by patrick013 » Sun Jan 31, 2016 7:33 pm

I always wanted a fund that did the Fortune 500, ticker RWL almost
does the same thing.

Comparatively ticker EPS, RWL, RSP, and VOO have similar returns
over 5 year period with EPS lagging behind. Five years is the most
history I can find with all included.

If we had 10 or 20 or longer years data we could really say one does
this and the others do something else, etc..

If they wanted the 500 to be equal weighted they would have done it
at the start no doubt. But they are all the best companies in the index.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Equal weight index funds

Post by slickwillbo » Sun Jan 31, 2016 8:03 pm

RSP is essentially a mid-cap fund since it weights the lower-valued companies in the S&P 500 the same as, say, Apple. Here's a chart comparing Vanguard's mid-cap index fund (VIMAX) and RSP.

Image

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Re: Equal weight index funds

Post by fortyofforty » Sun Jan 31, 2016 9:23 pm

Isn't following an "equal weight" strategy similar, at least in principle, to the monkey portfolio? Aren't you saying that every stock is correctly valued, so there is no downside to overweighting those at the bottom of the spectrum? I still think that such a strategy greatly increases volatility and risk in a portfolio.
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Re: Equal weight index funds

Post by nisiprius » Sun Jan 31, 2016 9:33 pm

in_reality wrote:
nisiprius wrote: 2) Not allowing for the fact that most people writing about investments are interested parties, and the "investment" industry has a vested interest in selling their products. In this particular case... Vanguard has an overwhelmingly dominant position in cap-weighted mutual funds, so many of Vanguard's competitors have a vested interest in convincing you that cap-weighted is the worst possible weighting and that anything but cap-weighting is better.
Why does Vanguard offer non-cap weighted funds? Because they need an alternative product to compete with Vanguard who has the overwhelmingly dominant position??? Um...
The Vanguard Global Value Factor UCITS ETF (VVAL)...
The Vanguard Global Momentum Factor UCITS ETF (VMOM)...
The Vanguard Global Liquidity Factor UCITS ETF (VLIQ)...
The Vanguard Global Minimum Volatility UCITS ETF (VMVL)...
:oops: :D Got me fair and square.

However, Vanguard is not and has never been just a provider of cap-weighted index funds. They have always offered a variety of... inconsistent... products, active and passive. Dimensional seems to be ideologically pure, Vanguard seems to be pragmatic.

(Also I don't think those ETFs actually exist yet, or if they do they're not offered in the US yet... do you know?)

I still stand by my comment. Over the last decade or so there's been a steady rising drumbeat in which the only constant is "cap-weighted sucks," and I think it's mostly the desire to have some little differentiator, some little fillip or twist, to justify a slightly higher expense ratio.

What's wrong with my third point... that you need to consider risk, and RSP risk adjusted reward is no higher than that of the cap-weighted S&P? That's really what I thought was my most important point. If you want mid-caps, buy a mid-cap fund, don't buy a magic-criterion fund that accidentally happens to emphasize mid-caps as a side effect.
Last edited by nisiprius on Mon Feb 01, 2016 8:28 am, edited 2 times in total.
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Re: Equal weight index funds

Post by ResearchMed » Sun Jan 31, 2016 11:06 pm

VMOM - London Stock Exchange.

Looks to be quite new, per CNBC search and price history.

Interesting.
Had no idea, either.

RM
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Re: Equal weight index funds

Post by nisiprius » Mon Feb 01, 2016 8:33 am

ResearchMed wrote:VMOM - London Stock Exchange.

Looks to be quite new, per CNBC search and price history.

Interesting.
Had no idea, either.

RM
I guess they've been offering the minimum volatility fund or something like it as a mutual fund, Vanguard Global Minimum Volatility Fund Investor Shares (VMVFX) since 2013. I remember now that it's one of the funds held in Vanguard Managed Payout fund, which is fully buzzword-compliant and has alternatives 'n' commodities 'n' all the kewl stuff. I can never remember exactly what's in it because they've changed the composition four or five times.

But I don't see the three others available, either as mutual funds or as ETFs... (yet?)
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Re: Equal weight index funds

Post by Call_Me_Op » Mon Feb 01, 2016 8:49 am

This is nothing more than a small-cap tilt (IMO). So yes, expected return (and risk) is higher.
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Re: Equal weight index funds

Post by lack_ey » Mon Feb 01, 2016 9:39 am

nisiprius wrote:I guess they've been offering the minimum volatility fund or something like it as a mutual fund, Vanguard Global Minimum Volatility Fund Investor Shares (VMVFX) since 2013. I remember now that it's one of the funds held in Vanguard Managed Payout fund, which is fully buzzword-compliant and has alternatives 'n' commodities 'n' all the kewl stuff. I can never remember exactly what's in it because they've changed the composition four or five times.

But I don't see the three others available, either as mutual funds or as ETFs... (yet?)
Continuing with this subtopic from the funds that in_reality pointed out...

First of all, actively manged funds are generally not cap weighted. US Vanguard's Global Minimum Volatility is actively managed. The four Vanguard UK ETFs mentioned earlier are actively managed.

Most sector, style, or factor funds (index funds) are cap weighted. Research Affiliates was invoked earlier; they are an exception and are behind non-cap-weighted funds in the form of the fundamental index products.

On a side note it may be worth pointing out that indexing is not as strong in most other regions, in part because of sometimes relatively worse results, both on an absolute and relative level compared to active funds.

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Re: Equal weight index funds

Post by quantAndHold » Mon Feb 01, 2016 10:02 am

OP, you're correct. Cap weight weighting buys a lot of yesterday's winners, which, in our mean reverting world, are likely to underperform in the future. Pretty much any other weighting will do better over the long term. Bogleheads will tell you to ignore the evidence that non-cap weight portfolios have done better over most of history, because "past performance" and all that, all the while buying large amounts of exactly what performed the best in the recent past in our cap weighted portfolios.

When you're looking at past performance, you have to judge whether the past performance is cherry picking data from particular periods or not, and also if the explanation of why something has outperformed passes the test for reasonableness. Most ETF's haven't been around for long enough to have that track record we really need to see how they'll do in all markets. So we're stuck reading research papers and deciding for ourselves.

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Re: Equal weight index funds

Post by nisiprius » Mon Feb 01, 2016 10:37 am

quantAndHold wrote:OP, you're correct. Cap weight weighting buys a lot of yesterday's winners, which, in our mean reverting world, are likely to underperform in the future. Pretty much any other weighting will do better over the long term. Bogleheads will tell you to ignore the evidence that non-cap weight portfolios have done better over most of history, because "past performance" and all that, all the while buying large amounts of exactly what performed the best in the recent past in our cap weighted portfolios...
It is mathematically impossible that "Pretty much any other weighting will do better over the long term"--unless you cross your fingers behind the words "pretty much any," and use it to mean "only the good ones, and anyone knowledgeable knows how to pick the good ones."

The set of all non-cap-weighted portfolios is the total market portfolio, after you remove all of the cap-weighted portfolios. The total market portfolio is cap-weighted. If you remove all the cap-weighted portfolios from the total market, what's left is, collectively, a cap-weighted portfolio. If you dip a bucket into the sea and pull out a bucket of water, the bucket is exactly as salty--and has the same percentages of magnesium, calcium, and gold--as the ocean as a whole, and after you remove it, the ocean is just as salty as it was before.

All that can be said about "pretty much any other weighting" is that any other weighting will have concentrations in it, and thus offers the potential for outperforming the market if the concentrations are right. The hidden assumption behind departures from cap-weighting is that the specific weighing incorporates a formula that automatically concentrates the portfolio in a beneficial way. Well, it's not such a hidden assumption with regard to any specific weighting--fundamental indexing, for example. But it's a hidden assumption behind the throwaway statements that "pretty much any other" weighting is better than cap-weighting.

Without a mental reservation, it's absurd to say that "pretty much any other weighting" is superior. Consider, for example, the portfolio of all stocks whose ticker symbols contain the letter N, weighted according to the cube root of its capitalization. That's not cap-weighted. It outperforms the market. Well, no, I'm just making that up, but if it doesn't, just try each of the 26 letters until you find one that does. Do you honestly believe that any of them is really superior to the total market itself? That's a rhetorical question! Of course not.

It is secretly not included in "pretty much any other."

So what, then, are your rules for picking weighting systems that are superior to the total market itself? "Any well-known weighting system?" "Any brand-name weighting system incorporated into a real-world mutual fund or ETF?"
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Re: Equal weight index funds

Post by garlandwhizzer » Mon Feb 01, 2016 12:08 pm

longinest wrote:

It is cheaper, because total-market index funds are almost always cheaper than other index funds.
More tax efficient, because total-market index funds have very low turnover.
It is simpler.
Changing the risk of the portfolio, as one advances in age and as the portfolio grows, simply involves increasing the allocation to bonds. There's no need to replace funds within the portfolio.
Lower risk of a significant index change, as the total market is what it is. Various total-market indices only have small differences. On the other hand, indices tracking only a part of the market (like small-cap stocks, or value stocks, or small-cap value stocks) do have significant differences in their composition, because nobody agrees on the definition of what is small, what is value, etc.
No front-running.
Easy to maintain.
A very good summary of the strengths of TSM. Gene Fama calls TSM the only true index fund.

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Re: Equal weight index funds

Post by Call_Me_Op » Mon Feb 01, 2016 12:36 pm

garlandwhizzer wrote: A very good summary of the strengths of TSM. Gene Fama calls TSM the only true index fund.
Yes, but so what? That does not translate to the best investment.
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Re: Equal weight index funds

Post by lack_ey » Mon Feb 01, 2016 12:54 pm

nisiprius wrote:So what, then, are your rules for picking weighting systems that are superior to the total market itself? "Any well-known weighting system?" "Any brand-name weighting system incorporated into a real-world mutual fund or ETF?"
This isn't directed at me, but if for example you look at the Research Affiliates papers on this subject (e.g. The Surprising Alpha From Malkiel's Monkey and Upside-Down Strategies), they have noted that randomly constructed portfolios tend to outperform (over a past period in which small and value were positive, and at least in part because of weightings there; though not just absolute performance but Sharpe too). Or most any construction but cap weighting or something that overweights stocks beyond cap weighting.

Another paper was posted earlier in the thread.

This in general suggests that diversified, tax-managed, buy-and-hold funds run at similar costs as index funds have a reasonable shot at outperforming. I mean, in theory this could be offered at an even lower cost than an index fund as you don't even have to license an index.

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Question about indexing vs active funds

Post by Taylor Larimore » Mon Feb 01, 2016 1:05 pm

On a side note it may be worth pointing out that indexing is not as strong in most other regions, in part because of sometimes relatively worse results, both on an absolute and relative level compared to active funds.
Lack_ey:

Do you have data to support the above statement? It appears to refute the work of Nobel Laureate, Wm Sharpe:
Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.
The Arithmetic of Active Management

Thank you and best wishes.
Taylor
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Re: Question about indexing vs active funds

Post by lack_ey » Mon Feb 01, 2016 2:49 pm

Taylor Larimore wrote:
On a side note it may be worth pointing out that indexing is not as strong in most other regions, in part because of sometimes relatively worse results, both on an absolute and relative level compared to active funds.
Lack_ey:

Do you have data to support the above statement? It appears to refute the work of Nobel Laureate, Wm Sharpe:
Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.
The Arithmetic of Active Management

Thank you and best wishes.
Taylor
Oh, sorry, that wording was confusing so I think you took the wrong meaning.

I mean that indexing does not have as strong a presence in other countries in terms of mindshare and AUM, not that indexing is not as good of a strategy in other countries. However, the latter part might also be true to some extent. Anyway, regardless of the reality of what works, it makes sense for Vanguard UK to be offering active ETFs of the kind in_reality pointed out if that's what investors want.

First of all, I know you like to talk about Sharpe's paper, but it is irrelevant in this context. We're not talking about the whole market, just active mutual funds. All investors together make up the whole and can't outperform in the aggregate, but active mutual fund managers don't manage 100% of the stocks (or 100% of the non-total-market-index stocks) available. If active mutual fund managers outperform other owners of stock such as retail investors and pension funds, it is possible that they beat the relevant benchmarks consistently.

We were talking about Vanguard UK funds, so let's look at the experience of the UK investor with the SPIVA scorecard for the region:
http://www.spindices.com/documents/spiv ... r-2015.pdf

See "Report 4: Average Europe Equity Fund Performance (Asset Weighted)"
edit: the four columns are 1-year, 3-year, 5-year, and 10-year returns, annualized, in percentage. Every other column is an index (e.g. S&P Europe 350) with the other representing the average (asset weighted) active fund for the category (e.g. Europe Equity).
Image

In many categories the active funds won, which in part is probably because small caps were better over the period and the benchmark may not really reflect the composition of the average active fund, but there you have it. Regardless of the underlying reason, such as a potential benchmark mismatch, luck, skill, somewhat less efficient markets, or what, given the results it makes sense that the adoption of indexing is not spreading as quickly elsewhere.

For reference, the US scorecard:
http://www.spindices.com/documents/spiv ... r-2015.pdf
Last edited by lack_ey on Mon Feb 01, 2016 3:20 pm, edited 1 time in total.

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Re: Equal weight index funds

Post by Northern Flicker » Mon Feb 01, 2016 3:10 pm

Cap-weighting was the observation that made passive investing work because you don't need to rebalance as different stocks move differently. Early attempts at passive investing were equal-weighted and the transaction cost was too high.

Perhaps transaction costs have become cheap enough that equal weighting is more viable. But if the concern is too much concentration in the largest stocks in the index, you would be better off with equal weighting at the asset class granularity, rather than at the individual stock granularity. For instance, hold 1/3 S&P500, 1/3 S&P Mid-cap 400, and 1/3 S&P Small-cap 600 (or Russell 2000). But I still prefer a cap-weighted portfolio.

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Re: Equal weight index funds

Post by Taylor Larimore » Mon Feb 01, 2016 3:26 pm

Lack_ey:

I used your link to the SPIVA Scorecard and read this:
Managers across all international equity categories were outperformed by their benchmarks over the 10-year investment horizon.
Best wishes.
Taylor
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Re: Equal weight index funds

Post by nisiprius » Mon Feb 01, 2016 3:31 pm

In addition to being feasible and low-cost, cap-weighting has some other things that are important. It's not just one of a random set of weightings that has a little fan coterie of its own, on the same level as the fan coterie for fundamental indexing, enhanced indexing, equal weighting, smart beta, etc. etc. It's special. Now that doesn't mean it's necessarily the best, but there's a reason for taking it as a reference point.

1) To tell the truth I haven't read the book but in 1922 Irving Fisher published a very influential book, The making of index numbers; a study of their varieties, tests, and reliability, which made a case for cap-weighted indexes being the appropriate way to measure the stock market. The methodology was adopted by the Cowles Commission in their Common-Stock Indices, 1871-1937 which is the source for all of those data sets going back to 1871, and may even be the source for so-called "S&P 500" data before 1937. In short, there was general agreement that cap-weighted indexes are the right way to measure the stock market, and that's why the S&P 500, which was actually created in 1957, is cap-weighted.

2) There's a body of theory in the textbooks which says that "the market portfolio," the set of all of the assets in a given market, has special characteristics and under a set of assumptions is mean-variance optimum. One online summary is here. It is probably this theory, plus the practical observation that active managers were not, in fact, beating the index, that led to the idea of index funds being in the air in the early 1970s, as it clearly was.

I don't think there's anything comparable for any other weighting. It's mostly pragmatic observations of past performance with qualitative hand-waving about why investors might or might not commit persistent behavioral errors. Early editions of Siegel's "Stocks for the Long Run" suggested that at that time Siegel actually agreed with cap-weighting. In later editions, he complained that the assumptions under which cap-weighting was optimal were not met, and indicated that he had developed a "noisy market theory" under which the modified weightings of "fundamental indexing" were optimal.
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Re: Equal weight index funds

Post by patrick013 » Mon Feb 01, 2016 3:43 pm

I can think of several pro's subjectively for RWL which
is the 500 weighted by Revenue.

Market share, economies of scale, profit capability, expansion
capability, product recognition, etc..

Time will tell. :)
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Re: Equal weight index funds

Post by lack_ey » Mon Feb 01, 2016 3:54 pm

Taylor Larimore wrote:Lack_ey:

I used your link to the SPIVA Scorecard and read this:
Managers across all international equity categories were outperformed by their benchmarks over the 10-year investment horizon.
Best wishes.
Taylor
Yes, you can see that in Report 1 but that's not as relevant as asset-weighted returns. If five managers each handling 10 million GBP lose to an index but one popular manager with 10 billion GBP wins, then the average active manager lost to the index. However, the average pound invested did better than the index, and this more accurately reflects the investor experience: on average, most investors weren't heavily allocated to the losing funds.

nisiprius wrote:I don't think there's anything comparable for any other weighting. It's mostly pragmatic observations of past performance with qualitative hand-waving about why investors might or might not commit persistent behavioral errors [emphasis added]. Early editions of Siegel's "Stocks for the Long Run" suggested that at that time Siegel actually agreed with cap-weighting. In later editions, he complained that the assumptions under which cap-weighting was optimal were not met, and indicated that he had developed a "noisy market theory" under which the modified weightings of "fundamental indexing" were optimal.
The usual arguments for the "noisy market theory" in this context (I haven't read Siegel's work and don't know if he makes the exact same formulation) do not require persistent behavioral errors.

The only real stipulation needed is that stocks are not all perfectly priced, and as a result the marginal contribution to risk/return is not all the same. This mispricing could arise from limits of arbitrage or various other practical breakdowns of perfect market efficiency in the real world, maybe disparate investor preferences and valuations that may be individually rational but not optimal in the aggregate, and/or but not requiring persistent behavioral errors. In this world, cap weighting is a method of systematically overweighting stocks with worse risk/return and underweighting stocks with better risk/return. It might well be that we don't know (or even that nobody knows) which stocks are which.

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Re: Equal weight index funds

Post by Jags4186 » Mon Feb 01, 2016 5:02 pm

I'd be interested in throwing some fun money into a Wilshire 5000 Equal Weighted Fund.

Alas, I do not believe a Wilshire 5000 Equal Weighted Fund exists.

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Re: Equal weight index funds

Post by nisiprius » Mon Feb 01, 2016 6:03 pm

Jags4186 wrote:I'd be interested in throwing some fun money into a Wilshire 5000 Equal Weighted Fund.

Alas, I do not believe a Wilshire 5000 Equal Weighted Fund exists.
It's worse than that. There was, in fact, an ETF with what I think was a very, very misleading name: "Guggenheim Russell 2000® Equal Weight ETF," EWRS

"Investment Objectives: Seeks to correspond as closely as possible, before fees and expenses, to the price and yield performance of the Russell 2000® Equal Weight Index."

Well, it's even worse than that because that ETF no longer exists, but I'll get to that in a second. I looked at it here: EWRS: What kind of "equal" weight is THIS? You see, that fund tracked the Russell 2000 Equal Weight Index. But... the Russell 2000 Equal Weight Index does not, as you might think, assign an equal weight to each constituent of the index. The allocations of the stocks in this "equal weight index" ranged from 0.29% and 0.26% for some down to 0.03% and 0.02% for others. In short, some of the "equal weight" constituents were given ten times as much weight as others.

In short, the fund had a misleading name because it tracked an index with a misleading name.

But... EWRS has been rechristened EWRC, the "Guggenheim S&P SmallCap 600 Equal Weight ETF", and now tracks the "S&P SmallCap 600® Equal Weight Index."

600, eh? That isn't much more than the number of stocks in the S&P 500 Equal Weighted index and ETF, which does approximate equal weight, with every stock constituting about 0.2% of the fund.

So if they can do it with the S&P 500 Equal Weight, they can do it with the SmallCap 600 Equal Weight, right? Every stock constitutes about 0.17% of the portfolio, right? Nope.

Image

Why is this important? It comes from the logic or illogic of the whole equal weighting idea. Because, if you cap-weight, then if you invest in the S&P 500, you may only have about 500/4000 = 1/8 of the listed stocks but you do have 80% of the market by dollars. That means that even the S&P 500 is not too bad an approximation to the total market. If you want cap-weighted, then you are only missing 20% of what you want.

But if you want equal-weight, then logically you really want to have all 4,000 stocks in the market. If you only have 500, equal weighted, then you only have 1/8 of the market, equal weighted, and you are missing 7/8 of what you want.
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Re: Equal weight index funds

Post by Phineas J. Whoopee » Mon Feb 01, 2016 6:47 pm

lack_ey wrote:...
The only real stipulation needed is that stocks are not all perfectly priced, and as a result the marginal contribution to risk/return is not all the same. This mispricing could arise from limits of arbitrage or various other practical breakdowns of perfect market efficiency in the real world, maybe disparate investor preferences and valuations that may be individually rational but not optimal in the aggregate, and/or but not requiring persistent behavioral errors. In this world, cap weighting is a method of systematically overweighting stocks with worse risk/return and underweighting stocks with better risk/return. It might well be that we don't know (or even that nobody knows) which stocks are which.
When you write "perfectly priced," and "perfect market efficiency," are you referring to the Efficient Market Hypothesis, which doesn't rely on perfect pricing, of which there never can be any in the first place, or are you talking about something else?

If you do mean the EMH, I posted about it in the fall, and what you're saying implies those who place limit orders fail to take information into account when deciding on their bids and asks; but not that you personally agree with their interpretation of the information, nor that you and they are in identical individual financial and risk circumstances.

If you mean something other than the EMH, may I ask what it is?

Thanks in advance.

PJW

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Re: Equal weight index funds

Post by Northern Flicker » Mon Feb 01, 2016 7:27 pm

Jags4186 wrote:I'd be interested in throwing some fun money into a Wilshire 5000 Equal Weighted Fund.

Alas, I do not believe a Wilshire 5000 Equal Weighted Fund exists.
If you saw some data on what you would pay in cumulative bid-ask spreads alone to regularly rebalance the smallest, say 2000 stocks in such a portfolio, you might change your mind.

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Re: Equal weight index funds

Post by lack_ey » Mon Feb 01, 2016 8:18 pm

Phineas J. Whoopee wrote:
lack_ey wrote:...
The only real stipulation needed is that stocks are not all perfectly priced, and as a result the marginal contribution to risk/return is not all the same. This mispricing could arise from limits of arbitrage or various other practical breakdowns of perfect market efficiency in the real world, maybe disparate investor preferences and valuations that may be individually rational but not optimal in the aggregate, and/or but not requiring persistent behavioral errors. In this world, cap weighting is a method of systematically overweighting stocks with worse risk/return and underweighting stocks with better risk/return. It might well be that we don't know (or even that nobody knows) which stocks are which.
When you write "perfectly priced," and "perfect market efficiency," are you referring to the Efficient Market Hypothesis, which doesn't rely on perfect pricing, of which there never can be any in the first place, or are you talking about something else?

If you do mean the EMH, I posted about it in the fall, and what you're saying implies those who place limit orders fail to take information into account when deciding on their bids and asks; but not that you personally agree with their interpretation of the information, nor that you and they are in identical individual financial and risk circumstances.

If you mean something other than the EMH, may I ask what it is?

Thanks in advance.

PJW
I'm talking about pricing better than the EMH would necessarily produce, where assets are some kind off CAPM ideal where any deviation from total market cap weighting—underweighting or overweighting any stock—produces a worse allocation. This is where the total market is optimal in the Markowitz sense because the marginal buyer or seller of stock effectively pushed the prices that way. Presumably this would only happen with EMH plus more stipulations about how the information is used to price securities.

More or less the point is that this state isn't achieved in real markets.

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Re: Equal weight index funds

Post by Phineas J. Whoopee » Mon Feb 01, 2016 8:28 pm

lack_ey wrote:...
I'm talking about pricing better than the EMH would necessarily produce, where assets are some kind off CAPM ideal where any deviation from total market cap weighting—underweighting or overweighting any stock—produces a worse allocation. This is where the total market is optimal in the Markowitz sense because the marginal buyer or seller of stock effectively pushed the prices that way. Presumably this would only happen with EMH plus more stipulations about how the information is used to price securities.

More or less the point is that this state isn't achieved in real markets.
I see.

Your use of the word "efficiency," especially combined with "perfect," threw me off. You're talking CAPM, not EMH. Thanks for the clarification.

PJW

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Re: Equal weight index funds

Post by Northern Flicker » Tue Feb 02, 2016 6:51 pm

quantAndHold wrote:OP, you're correct. Cap weight weighting buys a lot of yesterday's winners, which, in our mean reverting world, are likely to underperform in the future.
Why would this be? A company being large doesn't mean it has had recent performance exceeding its historical sample mean performance. A small-cap stock can overperform and still be a small-cap stock.

With a cap-weighted index, new investment buys yesterday's winners and losers. I think there will be alot more small stocks with recent overperformance than large stocks (partly because there are more small stocks) so equal weighting may actually take a bigger hit from any mean reversion that takes place.

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Re: Equal weight index funds

Post by Toons » Tue Feb 02, 2016 6:54 pm

"Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future.""

Do I hear VGENX? :happy
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Re: Equal weight index funds

Post by selters » Tue Feb 02, 2016 9:58 pm

If you want to invest in an equal weighted fund, then EUSA, iShares MSCI USA Equal Weighted ETF (https://www.ishares.com/us/products/239 ... ci-usa-etf) is the cheapest option right now, 0.15% ER. It follows the MSCI USA index, which contains the 600 largest stocks in the US, compared to the 500 for the S&P 500. For all practical purposes there is no difference between the S&P 500 og the MSCI USA indexes.

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Re: Equal weight index funds

Post by nisiprius » Tue Feb 02, 2016 10:07 pm

selters wrote:If you want to invest in an equal weighted fund, then EUSA, iShares MSCI USA Equal Weighted ETF (https://www.ishares.com/us/products/239 ... ci-usa-etf) is the cheapest option right now, 0.15% ER. It follows the MSCI USA index, which contains the 600 largest stocks in the US, compared to the 500 for the S&P 500. For all practical purposes there is no difference between the S&P 500 og the MSCI USA indexes.
And, please, what is the logical argument, based on "equal weighting," that explains why you would want to assign 0.167% weights to 600 of the stocks in the market, and
zero weights to the other 3,400?
Why is that considered "equal" weighting?
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Re: Equal weight index funds

Post by fortyofforty » Tue Feb 02, 2016 10:30 pm

nisiprius wrote:
selters wrote:If you want to invest in an equal weighted fund, then EUSA, iShares MSCI USA Equal Weighted ETF (https://www.ishares.com/us/products/239 ... ci-usa-etf) is the cheapest option right now, 0.15% ER. It follows the MSCI USA index, which contains the 600 largest stocks in the US, compared to the 500 for the S&P 500. For all practical purposes there is no difference between the S&P 500 og the MSCI USA indexes.
And, please, what is the logical argument, based on "equal weighting," that explains why you would want to assign 0.167% weights to 600 of the stocks in the market, and
zero weights to the other 3,400?
Why is that considered "equal" weighting?
It would seem that they choose 500 or 600 or some other limited number due to the near impossibility of equally weighting small and microcap stocks. Large scale buying and selling some of those tiny stocks would unduly influence pricing. So, to argue for equal weighting they must simultaneously argue for equal weighting of only large and midcap stocks. While academically interesting, I will stick with cap weighting, and Total Stock Market, at that.
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Re: Equal weight index funds

Post by lemonPepper » Mon Aug 08, 2016 6:54 pm

what a lively discussion. I learned a bunch.

One problem with equal weight is that some small companies would get more capital than they can handle efficiently. A company with revenues < $1bn would get too much inflow if people started doing equal weights.

The other side of the cap weight problem is that you have negative momentum e.g. you are buying more of AAPL today than in 2004. I get a feeling that cap weighting creates vicious circles: companies dropping in value will get less investment and may decline in price. This would be a ngihtmare if everyone believed in cap weighted investing.

But the reality is that many don't believe in index funds and they continue to set the prices. So my guess is momentum by index funds will be checked by active investors in both directions

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Re: Equal weight index funds

Post by BogleInvestorLondon » Mon Aug 08, 2016 7:27 pm

longinvest wrote:Why would market returns be insufficient to reach one's financial objectives? Why seek to beat the market? Beating the market is a negative-sum game, after fees (see: proof)
I really do not want to hijack this thread but that is not proof at all.

I know we are Bogleheads here but I index for many reasons and am broadly diversified. However, I also have an active fund and my guy has outperformed the market every single year for over 25 years. I was just checking my statement today (which I do about once a year) and looking at his excellent results compared to the market. No, he is not just lucky or some guy who flicks a coin 10,000 times and manages to call it correct every time.

I am huge on indexing and keeping things simple, that subject and the rubbish said just always seems to get me.

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Re: Equal weight index funds

Post by Taylor Larimore » Mon Aug 08, 2016 7:45 pm

However, I also have an active fund and my guy has outperformed the market every single year for over 25 years.
BogleInvestorLondon:

Your fund must be the best performing fund in the world. Please give us the fund name and ticker symbol.

Thank you and best wishes.
Taylor
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