4 ms·

This is not quite correct. There are other weighting methods (specifically, equal weighting) which would prevent this situation, whilst still remaining passive.

howlin 9y ago
You would have to actively rebalance to keep equal weighting, so it is not as passive as typical market cap weighting.
- brndnmtthws 9y ago
  You still have to rebalance market cap weighted funds, just much less so. Market cap weighted is indeed more efficient, but that's only assuming most stocks don't do things like pay dividends.
pedrocr 9y ago
I'd argue an equal weighted index is no longer passive. You're actively making a bet that smaller companies will outperform bigger companies. Someone else will be taking the other side of that bet. Me with my cap weighted index will get the average of the two and be actually passive.
- perl4ever 9y ago
  But many investors are going to take the side of big companies, not because they are choosing the optimal approach, but because they have to, because they have too much capital to invest in small companies. So it's not logical to assume their returns must be equal on average.
  - pedrocr 9y ago
    I didn't say their returns would be equal, I said my returns will always be equal to the average of the market exactly because I'm a passive investor. The sum of all bets is what I'll be making. The standard text on that: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm As for there not being enough of the small companies available to do the equal weighted S&P500, the smallest companies in the index have 3.5B$ in market cap. So there's almost 2T$ of that mix available and there would be much more if that amount of capital suddenly decided to implement that strategy as the market caps of the bottom of the S&P500 index would certainly rise significantly.

howlin 9y ago

You would have to actively rebalance to keep equal weighting, so it is not as passive as typical market cap weighting.

brndnmtthws 9y ago
You still have to rebalance market cap weighted funds, just much less so. Market cap weighted is indeed more efficient, but that's only assuming most stocks don't do things like pay dividends.

pedrocr 9y ago

I'd argue an equal weighted index is no longer passive. You're actively making a bet that smaller companies will outperform bigger companies. Someone else will be taking the other side of that bet. Me with my cap weighted index will get the average of the two and be actually passive.

perl4ever 9y ago
But many investors are going to take the side of big companies, not because they are choosing the optimal approach, but because they have to, because they have too much capital to invest in small companies. So it's not logical to assume their returns must be equal on average.
- pedrocr 9y ago
  I didn't say their returns would be equal, I said my returns will always be equal to the average of the market exactly because I'm a passive investor. The sum of all bets is what I'll be making. The standard text on that: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm As for there not being enough of the small companies available to do the equal weighted S&P500, the smallest companies in the index have 3.5B$ in market cap. So there's almost 2T$ of that mix available and there would be much more if that amount of capital suddenly decided to implement that strategy as the market caps of the bottom of the S&P500 index would certainly rise significantly.