The Trouble With Market-Cap Weighting
Some strategies don't benefit from a cap-weighted approach.
Market-cap-weighted indexes have their benefits. Funds that track cap-weighted indexes cut back on turnover and the related trading costs. They also grasp the market’s collective opinion of each stock’s relative value, a consensus that has historically proven tough to beat. But using a cap-weighted approach with certain markets or strategies can compromise diversification and intended factor exposure.
How Market-Cap Weighting Works
The stock market, like any other market, is simply the sum of all transactions for shares of publicly listed companies, millions of which are conducted every day. Hour by hour, minute by minute, Benjamin Graham's voting machine is hard at work as market participants express their opinions regarding a company's future prospects through the price at which its shares transact.
Daniel Sotiroff has a position in the following securities mentioned above: VEA. Find out about Morningstar’s editorial policies.