The Benefit of a Relative Value Rebalance
We’ve written a very similar blog post on this concept, focusing purely on WTSEI, and you’ve read many blog posts about the potential benefits of a relative value rebalance occurring annually. While those posts addressed the concept from a standpoint of valuation, the process also refocuses the Indexes on constituents that make up what we believe to be mid-cap and small-cap stocks, respectively, as opposed to just holding on to top performers while they potentially migrate from small- to mid- or from mid- to large-cap status.
• WTSEI: Each year, WTSEI selects the bottom 25% of the market capitalization remaining after the largest 500 firms have been removed from WTEI, WisdomTree’s broadest measure of profitable firms in the United States. Doing so this year dropped WTSEI’s weighted average market capitalization by almost 10%; and if one factors in the average reduction across all rebalances, it was about 16%.1
• WTMEI: Each year, WTMEI selects the top 75% of the market capitalization remaining after the largest 500 firms have been removed from WTEI. Doing so this year dropped WTMEI’s weighted average market capitalization by approximately 9%; and if one factors in the average reduction across all rebalances, it was about 11%.2
The other indexes also refocus their size exposures, attempting to zero back in on the market’s small-cap or mid-cap size segments, but their market capitalization weighting process has a tendency to put the most weight in the largest qualifying firms.
The Bottom Line of this Analysis: A number of the market cap-weighted small-cap indexes have been drifting toward having substantial weight in stocks we consider mid-cap stocks. WTSEI looks to us to be a purer form of the small-cap segment. The same can be said for mid-cap stocks’ tendency to drift toward larger-cap stocks, while we believe WTMEI is a better representation of the mid-cap segment than many other market cap-weighted indexes.
1Sources: WisdomTree, Bloomberg. Based on annual rebalancing occurring from Index inception (2/1/2007) to 12/31/2013.
2Sources: WisdomTree, Bloomberg. Based on annual rebalancing occurring from Index inception (2/1/2007) to 12/31/2013.
Important Risks Related to this Article
Investments focusing on certain sectors and/or smaller companies increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility.