Weighting game: New 'lazy' portfolio using 'fundamental' ETFs sparks furor

[chinaco]

Anybody see this?

Is traditional indexing the old fashion and out of style approach? Is this the new way to go? Using index weights other than market cap. Wisdom tree uses earning and dividends for weights. Bogle is skeptical. Yes, yes, yes... I am trying to spark a debate.

WhaDaYa think?

The ETF expense ratio is fairly low... looks to be below .5% Some at .48%, some at .28%.

http://www.marketwatch.com/news/story/new-lazy-portfolio-using-fundamental/story.aspx?guid=%7B2C36A4F9%2D884E%2D4CF2%2DA657%2DC57BB42B9D6E%7D&dist=TNMostRead

http://www.wisdomtree.com/home.asp

 

[boutros]

Schwab also started offering open-ended fundemental index funds based on the FTSE RAFI Indexes in 3 flavors: large domestic, small-mid, and international.

Schwab Link




MODERATOR EDIT: Shortened URL

 

[justin]

"Is traditional indexing the old fashion and out of style approach?"
Yep - definitely agree. Indexing isn't very popular.


"Is this the new way to go?"
Time will tell, but my guess is "no".

Just because something isn't popular doesn't change it's viability as an investment vehicle.

 

[gandalf42]

There are different sub-questions in your initial post.

ETFs vs Mutual Funds: ETFs make sense if you have large $ of a few funds, and don't buy/sell/or rebalance often.

Cap weighted index vs "other" weighted indexes: Bogle goes off on the issue of not buying in on the Wisdomtree dividend methodology being the right guideline, and he makes good points. He also goes off on managed funds vs. non-managed fund expenses and he's right on that. But he then he concludes that cap weighting is therefore the right solution ignoring other options. What about equal weighting? What about an index fund based on dividend stocks that have paid increasing dividends for X years? These don't need active management.

I am not totally sold on cap weighting which puts you heavily into a few companies. If I want the top 500 corporations why not equal weighting instead of the SP500 cap weighting? If we are out to "buy the market" why do we tilt the market towards market cap?

 

[d]

If we are out to "buy the market" why do we tilt the market towards market cap?

... because that is the market! if you bought equities "equal weight" or by some other weighting, you would not be capturing the market weighting, which is reflected by market capitalization. one can obviously create any kind of index they might chose, but if one wants to index "the market", there's only one way to do that.

 

[gandalf42]

It depends on your definition of the market. Just because the SP500 defines it with market cap doesn't mean everyone needs to fall in line behind.

 

[d]

1) the S&P500 does not define the market ... it has been used as a surrogate because it was the first available index.
2) the market is defined by where the money is ... hence cap weighting.

 

[rmark]

Equal weighting was tried in the original index fund, circa 1975. The cost of rebalancing back to equal weights was too high. The advantage of cap weighting is that all stocks are always held in the proper proportion, without rebalancing costs.

 

[gandalf42]

Equal weighting was tried in the original index fund, circa 1975. The cost of rebalancing back to equal weights was too high. The advantage of cap weighting is that all stocks are always held in the proper proportion, without rebalancing costs.

I don't understand why there would be a diference in costs of keeping something in balance based upon caps vs keeping it in balance based upon equal weighting. How do you "hold all stocks in proper proportion" without rebalancing?

 

[gandalf42]

2) the market is defined by where the money is ... hence cap weighting.

OK,that's true as a snap shot of the market today. But the market is an evolving animal. Small caps today are large caps tomorrow. Some large caps today are gone in the future.

So, my point is do I want to buy today's snapshot i.e. a today version of a cap weighted index or buy an equal weighted index to allow equal opportunities for growth? The cap weighted index heavily reflects what has happened in the past coupled with expectations for the future. Is this what you want? Its a philosophical question with no right or wrong answer. I just think the SP500 index for large caps is one I question the most as it is so heavily weighted to the top few stocks. Folks tend to buy large caps for stability..why then buy an index tilted to a few stocks? Seems a contradiction of intent.

 

[justin]

I don't understand why there would be a diference in costs of keeping something in balance based upon caps vs keeping it in balance based upon equal weighting. How do you "hold all stocks in proper proportion" without rebalancing?

I mean this in the nicest possible way, but you don't understand the fundamentals of cap weighting versus equal weighting if you are asking this question seriously.

Cap weighting requires no rebalancing. When a security increases or decreases in value (and accordingly changes its market cap), it retains its market cap weighting without any need for purchases or sales.

Equal weighting requires rebalancing any time the relative value of an equity deviates from an equal share of the whole index value (which will happen for most securities on a daily basis). Transaction costs occur at every buy/sell to maintain an equal weighting. Like rmark said, that's why the first index fund failed.

 

[chinaco]

When you say equal weighting Do you mean unweighted index (similar to the Value Line Index)?


rmark - did you indicate that this has already been tried? Is there any historical info for the fund?

According to Gus Sauter, these fundamental index fund are more actively managed and tend to tilt toward value and small cap. He indicates if you want that type of index, it is available in the SCV, SC, MC, etc...

http://www.marketwatch.com/news/story/story.aspx?guid=%7B5AE34D55%2D5C93%2D494A%2DB433%2DFDDF3423878F%7D&dist=rss

If one looks at the component of the Wisdom Tree 500 earning index EFT. It is based on: "Core Earnings, computed by Standard & Poor’s, as the weighting metric. Core Earnings is a standardized calculation of earnings developed by Standard & Poor’s designed to include expenses, incomes and activities that reflect the actual profitability of an enterprise’s ongoing operations."

http://www.wisdomtreeindexes.com/index-details.asp?indexid=70

The same companies just slightly different allocations per company... as would be expected. Wisdom tree indicates that it has out performed the S&P 500 index.

 

[gandalf42]

I mean this in the nicest possible way, but you don't understand the fundamentals of cap weighting versus equal weighting if you are asking this question seriously.

I was serious but you're right I was confused. Thanks for setting me straight!

I recant of my previous statements re. equal weighted indices.

 

[ats5g]

Check out what Bogle and F&F wrote in the Journal of Indexes:

False Promises: Index funds that promise to beat the market

Straight Talk: Fama & French

See also Fundamental Indexing and the Three-Factor Model

- Alec

 

[rmark]

I think Wells Fargo sponsored the original index fund, using equal weighting.

 

[Spanky]

if you are interested in an equal weighted fund, consider the exchange-traded Rydex S&P Equal Weight Fund (RSP). It has outperformed that the S&P index since its inception in 2003.