The Performance of Characteristics‐based Indices¹

Abstract

This paper analyses a set of characteristics-based indices that, it has been argued, outperform market cap-weighted indices. We analyse the performance of an exhaustive list of these indices and show that i) the outperformance over value-weighted indices may be negative over long time periods, and ii) there is no significant outperformance over equal-weighted indices. An analysis of the style and sector exposures of characteristics-based indices reveals a significant value tilt.When this tilt is properly adjusted for, the abnormal returns of these indices decrease considerably. Moreover, it is straightforward to construct portfolios with higher Sharpe ratios than characteristics-based indices through factor or sector tilts.

In Defence of Capitalisation Weights: Evidence from the FTSE 100 and S&P 500 Indices

“…Hence, in the absence of convincing evidence to the contrary, capitalisation‐weighted indices remain the most theoretically appealing, and the most transparent benchmarks for measuring the aggregate performance of equity markets. The findings are consistent with those of other researchers (see Malkiel, 2003; Perold, 2007; Kaplan, 2008; Ranaldo and Haberle, 2008; Jun and Malkiel, 2008; DeMiguel et al ., 2009; Amenc et al ., 2009).…”

“…(2005) and Hirschey (2001) to the effect that capitalisation‐weighted indices are harmful to investors' wealth. However, these concerns are questioned by other researchers (see Malkiel, 2003; Perold, 2007; Jun and Malkiel, 2008; Kaplan, 2008; Ranaldo and Haberle, 2008; DeMiguel et al ., 2009; Amenc et al ., 2009). These authors argue that (a) if markets are efficient and capitalisation weights are equilibrium weights, as in the Capital Asset Pricing Model (CAPM), any form of portfolio or benchmark optimisation that results in constituent weights that differ from market capitalisation weights is a form of active portfolio management strategy, and (b) excess returns that arise from such strategies may be explained by style, size, momentum, or other biases.…”

An Anatomy of Fundamental Indexing

“…Many studies do find that, after the standard regression-based correction for size and value exposure, there still is an alpha return left (Stotz et al, 2007;Houwer and Plantinga, 2009;Peltomäki, 2010;Mihm and Locarek-Junge, 2010;and Forbes and Basu, 2011). Others disagree, like Jun and Malkiel (2008), Amenc, Goltz andLe Sourd (2008), andWalkhäusl andLobe (2010).…”

Robustness of Smart Beta Strategies

“…For example, fundamentals-weighted portfolios typically have value tilt and minimum-volatility strategies exhibit low beta tilt (see for example Scherer [2011], Blitz and Swinkels [2008], and Amenc et al [2008]). For example, fundamentals-weighted portfolios typically have value tilt and minimum-volatility strategies exhibit low beta tilt (see for example Scherer [2011], Blitz and Swinkels [2008], and Amenc et al [2008]).…”

“…Many studies have underlined the importance of factor exposures in explaining part of the outperformance of portfolio strategies over cap-weighted indices (see Jun and Malkiel [2007], Amenc et al [2008]). It is a particularly important robustness check in the case of single-and multi-factor strategies because it discloses what portion of a strategy's performance is indeed derived from its exposure to intended risk factor and how much can be attributed to other factors and unexplained alpha.…”