Alternate Equity Indexation Method

Abstract

Trillions of dollars are invested globally in equity indexes that are directly tracked by fund managers and exchange-traded funds (ETFs). Fund managers usually aim to outperform the underlying index over the long term as higher returns entice investors to invest in such funds. The efficient market hypothesis (EMH), however, states that all public information is priced into stocks, so it is hard for active fund managers to easily beat the underlying index. Most global indexes are either market-capitalization weighted (also known as market-cap weighted or cap-weighted) or price-weighted indexes. The Dow Jones Industrial Average (DJIA) is a pre-eminently developed market index (tracked by fund managers and ETFs) as well as a price-weighted index composed of 30 stocks. Recently, researchers have introduced alternate equity indexation (AEI) methods, such as fundamental, risk-based, and risk-weighted alpha indexations, which provide passive methods that aim to outperform underlying indexes on a long-term basis.