Capitalization weighting, equal weighting and inverse market-capitalization weighting schemes are special cases of a more general class of factor tilt indexes that embed specific and explicit levels of size exposure. This is of direct relevance to the continuing debate regarding the performance outcomes of diversified weighting schemes and, in particular, whether such outcomes stem from an inherent property of diversified weighting schemes or is the result of traditional factor effects. We show that the fundamental relationship between all of these weighting schemes is via a simple tilt, and that the strength of this tilt determines the levels of size exposure, diversification and investment capacity.
Read this paper for:
- An answer to whether the log market-capitalization distributional assumption is valid for certain universes of stocks
- A demonstration of how market capitalization, equal and inverse market-capitalization weighting schemes are related to each other by a simple tilting mechanism
- A description of an analytical framework that may be used to derive theoretical relationships for the levels of factor exposure, diversification and investment capacity of equal, market and inverse market-capitalization weighting schemes and a comparison of these theoretical predictions with empirical findings
- Views encompassing the entire spectrum of size exposure, in which we compare the theoretical expressions for factor exposure, diversification and investment capacity with the empirically-derived values for these more general portfolios
- A comparison of the performance outcomes of these alternative constructs
- Additional information regarding other common portfolio-weighting schemes