Fundamentally weighted indices are worth considering
The EQDP’s focus has been on incentives, listings and disclosure, but index construction deserves some attention
Add BT as a preferred source
SHOULD good stock market indices merely reflect the size and breadth of the market, or should they also offer investment value?
In 2005, Robert Arnott, Jason Hsu and Philip Moore challenged the industry convention that indices must be weighted by market capitalisation. Their critique was straightforward but powerful: Capitalisation-weighted indices mechanically allocate more capital to stocks whose prices have already risen the most, regardless of whether those price increases are justified by fundamentals.
Over time, this can result in indices that are systematically biased towards overvalued companies while under-representing firms whose share prices lag despite solid underlying businesses.
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