Alternatives to indexing (alternatives to cap weighted indexing)

[jIMOh]

I was reading various financial literature on a recent vacation.

One article caught my attention in that there is a flaw with cap weighted indexes- when markets go up the market caps of big companies get inflated and become a bigger % of the index.

It listed one fund (by Schwab) which used a different index approach, and a google search of "alternatives to index investing" turns up a few articles as well.

Curious if anyone here uses other indexing methods (meaning uses funds which are indexed to something which is NOT cap weighted) and what those investments are. Thx.

 

[dex]

Check out Rydex funds - I think they have a non cap weighted fund you can use for comparisons.

 

[HFWR]

Wisdom Tree has fundamentals-weighted funds.

 

[photoguy]

The big advantage to cap-weighting is that changes in the price of the stock don't require any selling or buying in the index. This minimizes the taxable impact.

Another thing to consider is that many indexes target a group stock by certain criteria such as size or value (p/e, p/b, etc). Within that group, the stocks may be cap-weighted but if they appreciate (depreciate) too much, they are sold and leave the index.

See the following vanguard link for further discussion:
https://global.vanguard.com/international/hAmeEN/research/IndexConstructionEN.html

 

[kyounge1956]

I was reading various financial literature on a recent vacation.

One article caught my attention in that there is a flaw with cap weighted indexes- when markets go up the market caps of big companies get inflated and become a bigger % of the index.

It listed one fund (by Schwab) which used a different index approach, and a google search of "alternatives to index investing" turns up a few articles as well.

Curious if anyone here uses other indexing methods (meaning uses funds which are indexed to something which is NOT cap weighted) and what those investments are. Thx.

There's a book about one of the alternatives to cap-weighting. Here's a thread about it from earlier this year. ISTM I also remember a thread on the topic over at Bogleheads, but I can't find it right now. If I do, I'll add a link.

 

[chinaco]

Value Line tracks unweighted indexes.

unweighted indexes provide more data about the market by stripping out capitalization. It offers an indication of broad market activity where larger companies in the index do not obscure activity in smaller companies.

 

[Culture]

The big advantage to cap-weighting is that changes in the price of the stock don't require any selling or buying in the index. This minimizes the taxable impact.https://global.vanguard.com/international/hAmeEN/research/IndexConstructionEN.html

Came to say this. My job here is already done.

 

[jIMOh]

The big advantage to cap-weighting is that changes in the price of the stock don't require any selling or buying in the index. This minimizes the taxable impact.

Another thing to consider is that many indexes target a group stock by certain criteria such as size or value (p/e, p/b, etc). Within that group, the stocks may be cap-weighted but if they appreciate (depreciate) too much, they are sold and leave the index.

See the following vanguard link for further discussion:
https://global.vanguard.com/international/hAmeEN/research/IndexConstructionEN.html

The existing shares don't need rebalancing, but any new money is now buying those stocks at inflated market caps and prices... and there is more to investing (indexing) than just avoiding taxable events.

My understanding of the alternate techniques from the 2 articles I read on it suggested that as high market cap stocks go up in price, the funds need to buy more of those stocks (with new money) and that buying inflates the prices and market caps even more, so even though no taxable event happened, the stock price does not reflect a real value of the stock.

Thx for the post, but thought I would chime that comment in.