Subject: Re: Bogle , back to the real world,
Jim,

An excellent article to track down is "The Surprising Alpha From Malkiel's Monkey and Upside-Down Strategies". It's a test of all the "smart alpha" strategies which weight stocks within broad portfolios in ways other than by market cap. They also tested the *reverse* of every strategy: e.g., heavily weighting the very worst firms ranked by ROE, not just the test of overweighting the very best. The prosaic but strong result was that virtually every "smart alpha" strategy beat the S&P 500. The more startling result: so did virtually every reversed strategy. The main conclusion was that capitalization weighting is a singular outlier...to the down side. Any other weighting (at least from the long list that they used, or their inverses) worked better. Equal weight is one of the simplest non-cap strategies, and minimizes company specific risk.

You can find that paper on line by searching the title. The main page about it at Research Affiliates has a broken link, but it's out there.

I have it. Results from the paper:
Global developed markets 1,000 stock portfolio 1991-2012:
Cap weight 7.15%
Equal weight 8.36%
Book Value weighted 9.5%
Fundamental weighted 11.00%
5-year Earnings weighted 11.2%

I buy your explanation of why cap weighting is sub-optimal. Joel Greenblatt has written on the subject also:
"In effect, if emotions really do drive certain stocks to be overpriced, a market cap weighting guarantees that we will own an inferior portfolio. We don't even have to identify which stocks are overpriced and which are underpriced. As long as we know that at least some stocks are mispriced relative to their fair value, weighting by market cap will ensure that we buy too much of the overpriced ones and too little of the bargains".
(Greenblatt (2011), The Big Secret for the Small Investor, page 99).

In that book Greenblatt goes on to discuss various weighting schemes, result:
Cap weight < equal weight < fundamental weight (e.g. RAFI) < Greenblatt's "Value weight" (low price/high ROC)

The authors of that white paper attributed the outperformance to the "factor" stuff, but I think that's nonsense based on my own analysis, and the fact that most of the "factor" outperformance research has been debunked, being mostly liquidity related. In the end, it doesn't matter all that much WHY it works. Just avoid cap weight in all your investing. (and never use an "at market" order!)

I'm confused about "factor" vs "quant" (or mechanical) investing. Isn't factor investing an application of quant methods? For example, you find companies with high ROE have tended to outperform on average, which makes sense, then select a portfolio of stocks using that "factor". Isn't this what the factor investing industry is doing?