Investors who are using exchange traded funds that track market-capitalization-weighted indices could be missing out as more fund sponsors engineer ETFs based on “enhanced,” “smart-beta” or “intelligent” indices that mimic actively managed strategies.
According to Cass Business School, returns of traditional, market-capitalization-weighted indices are lagging behind so-called alternative indices by as much as 2% a year over time, reports Andrew Blackman for the Wall Street Journal.
Nevertheless, the market-cap-weighted approach also has its benefits, and investors should consider the merits of every indexing methodology.
“We’re not here to bury cap-weighted indexing as an approach,” John Belgrove, senior partner at consulting firm Aon PLC unit that sponsored the research, said in the article. “It has a lot of advantages, especially around transparency. But we want investors to be conscious that it’s a choice, and there are other choices available.”
Critics of market-capitalization weighted indices argue that the methodology leaves an index’s overall value vulnerable to reversals in a few big stocks that have registered significant gains.
In contrast, the alternative indexing methodologies lean toward small-cap and value-oriented stocks, or both. Consequently, these types of stocks consistently outperform large-cap stocks and so-called growth stocks in rapidly expanding companies – this phenomena is also known as the Fama-French model.