No. of Recommendations: 4
Manlobbi, you wrote "As a stock declines, an equal weight index buys more of it, but only subtly." Why would such an index buy more? Isn't the position fixed at, say, 1/500th of the index value?
The target allocation of an equal weight index is frequently rebalanced to equal weight. Take QQQE for example, with the target allocation being a 1% holding of each of the largest 100 stocks in the NASDAQ. If one firm doubles in price to then become a 2% position, then it needs to return to 1% so the index sells half the holding to return it to 1%. Conversely if a firm halves in value to 0.5% of the index then a 0.5% position is purchased to return it to 1%.
The equal weight index forces systematic selling of stocks rising in quotes, and buying of stocks that fall in quotes.
Much, but importantly not all, of this rising quotes is associated with rising value. As a result there is a mild effect of the equal eight index selling overpriced positions and purchasing more underpriced positions. Call this the 'trading advantage'.
It also had the disadvantage of not allowing considerable "winners to run". That has worked well for cap weight indexes the last 5 years, but was not always such a large advantage.
The second advantage of equal eight indexes is that they avoid avoid a bias of exposure in firms that already have market dominance and may have less room to grow. Call this the 'economic advantage'. In the long past history going back a century, the largest firms performed worse than the medium sized firms because once you have 'made it', you could no longer have a 100x return from there except through the effect of dividends over very many decades. However the last ten years have been a historical aberration, with the largest firms continuing to have superior returns, thus the ordinary cap weighted Nasdaq QQQ recently outperformed the equal weight Nasdaq QQQE. That may continue for a while but longer term I would rather bet on 100 years of history than 10.
- Manlobbi
