The Lemon Fool

Interesting discussion on shrewdm.com :
https://www.shrewdm.com/MB?pid=47209991 ... hread=true

Here's a March 2023 update of Hendrick Bessembinder's work published in 2018 showing that a very high fraction of all wealth creation has come from a small number of stocks. The original work covered data back to 1926; the update covers the period 1990- 2020. ...

Note: I believe this statement is deceptive, see discussion for a possible rebuttal.

The main "analysis" there relies on a claim that seems to go against what most people say - that capitalization-weighted index trackers outperform most funds. The claim on that board, without a source that I can see (presumably discussed there so much they all take it as read) is

"Remember that conventional market-wide cap-weight indexes are big outliers in terms of [bad] performance: almost any other portfolio weighting method you try will usually do better, most obviously equal weight."

Now, I haven't seen comparisons with equal weight indexes, but active funds are said, in pretty much all analyses of developed markets, to underperform cap-weighted index trackers.

EthicsGradient wrote:Now, I haven't seen comparisons with equal weight indexes, but active funds are said, in pretty much all analyses of developed markets, to underperform cap-weighted index trackers.

There will be some that do better than the index but taken as a whole it is a mathematical certainty that active funds will underperform simply because they're charges are that much higher.

BpE

Bubblesofearth wrote:

EthicsGradient wrote:Now, I haven't seen comparisons with equal weight indexes, but active funds are said, in pretty much all analyses of developed markets, to underperform cap-weighted index trackers.

There will be some that do better than the index but taken as a whole it is a mathematical certainty that active funds will underperform simply because they're charges are that much higher.

BpE

This is a new form of mathematics. In normal mathematics it is far from a "certainty": it is only true if raw fund outperformance is smaller than the difference in charges. One needs to remember that market participants other than active funds can significantly underperform the index.

GS

EthicsGradient wrote:Now, I haven't seen comparisons with equal weight indexes, but active funds are said, in pretty much all analyses of developed markets, to underperform cap-weighted index trackers.

Well, active funds are a separate discussion, there's no mention of active funds on that thread.

SteadyAim wrote:

EthicsGradient wrote:Now, I haven't seen comparisons with equal weight indexes, but active funds are said, in pretty much all analyses of developed markets, to underperform cap-weighted index trackers.

Well, active funds are a separate discussion, there's no mention of active funds on that thread.

I would say "almost any other portfolio weighting method you try will usually do better" includes active funds.

As far as a equal weight vehicle goes, there don't seem to be many available in the UK (there was a FTSE 100 equal weight ETF, but it seems to have closed in 2019). JustETF did show the XTrackers S&P 500 ETF, which has a cap-weighted equivalent from Xtrackers, and they can be compared from 10/6/2014:

Past performance  1 yr  3 yr  5 yr   max     
Equal weight:    -0.77 47.43 60.51 185.44
Standard:         8.10 47.08 80.48 243.25

https://www.justetf.com/uk/etf-profile. ... YC90#chart

so the cap-weighting has usually worked out better. There certainly needs to be some evidence for the claimed superiority of equal weighting.

Equal weighted worse by a decent margin, although it’s shone through during short periods: EUSA in portfoliovisualizer.com

Initial equal weighted, left to find its own cap weighting .... I believe has historically worked well. Rebalancing back to equal weightings yearly/whatever involves costs/trading overheads.

With initial equal weighting, left to run as-is, a few of the set will do very well, uplifts the whole. Better to have equally initially weighted into those rather than initially tilting larger amounts into those that had done well in the rear-view-mirror, that may not reflect that in forward time, but where when more was invested in those (cap weighted) left less having been invested in those that were in forward-time the right-tail/best case stocks.

https://www.mauldineconomics.com/images ... 040309.pdf

https://www.forbes.com/global/1999/0614 ... 51584b68ff

1nvest wrote:Initial equal weighted, left to find its own cap weighting .... I believe has historically worked well. Rebalancing back to equal weightings yearly/whatever involves costs/trading overheads.

With initial equal weighting, left to run as-is, a few of the set will do very well, uplifts the whole. Better to have equally initially weighted into those rather than initially tilting larger amounts into those that had done well in the rear-view-mirror, that may not reflect that in forward time, but where when more was invested in those (cap weighted) left less having been invested in those that were in forward-time the right-tail/best case stocks.

https://www.mauldineconomics.com/images ... 040309.pdf

https://www.forbes.com/global/1999/0614 ... 51584b68ff

The second article, as well as being somewhat dated now, doesn't (AFAICS) state equal weighting on purchase.

However, it's very much my own view that initial equal weight and the left alone is not only a sound strategy but the most important learning from all the HYP posts. I suspect outperformance relative to the appropriate index would also be found for portfolios following other criteria (growth, small-cap etc). Critics wail about imbalances building up but this is a natural evolution of markets where the majority of gains are driven by a relatively small number of stocks.

The two main reasons for the good performance are, IMO, costs driven down to the minimum and the mathematical certainty that diversification benefit is not fully reflected in share prices.

Of course there will be a dearth of data for this kind of strategy because it's almost impossible for funds to follow it on an ongoing basis.

BoE

And we all know that the Barclays Equity Gilt study, the Credit Suisse year book and Jeremy Siegel demonstrate that the bulk of equity returns do not come from capital growth.

OhNoNotimAgain wrote:And we all know that the Barclays Equity Gilt study, the Credit Suisse year book and Jeremy Siegel demonstrate that the bulk of equity returns do not come from capital growth.

It would do if it wasn't paid out as income and then reinvested.

I think there have been many studies that show that the returns of all indices are dominated by a few companies and that the majority have lacklustre returns. It’s rather like what is said about university - you only use 2% of what you learn - it’s just a shame when you’re a student you can’t predict the 2%. So life for investors would be great if we could pick those super achieving winners. But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns.

Just to illustrate the point in Q1 2023 just 10 companies within the S&P 500 accounted for 90% of the gains. https://www.nasdaq.com/articles/top-10- ... f-q1-gains

AshleyW wrote:I think there have been many studies that show that the returns of all indices are dominated by a few companies and that the majority have lacklustre returns. It’s rather like what is said about university - you only use 2% of what you learn - it’s just a shame when you’re a student you can’t predict the 2%. So life for investors would be great if we could pick those super achieving winners. But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns.

Just to illustrate the point in Q1 2023 just 10 companies within the S&P 500 accounted for 90% of the gains. https://www.nasdaq.com/articles/top-10- ... f-q1-gains

But the other 98% of what you learn at university gives you the context for the 2% that you do use.

'But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns'.

I can't prove that that statement is untrue but neither can you that it is. My opinion though is that it is not true. The only way you can 'buy the market' is to invest in a tracker but I am not at all sure that most of us do that.

Dod

AshleyW wrote:I think there have been many studies that show that the returns of all indices are dominated by a few companies and that the majority have lacklustre returns. It’s rather like what is said about university - you only use 2% of what you learn - it’s just a shame when you’re a student you can’t predict the 2%. So life for investors would be great if we could pick those super achieving winners. But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns.

Just to illustrate the point in Q1 2023 just 10 companies within the S&P 500 accounted for 90% of the gains. https://www.nasdaq.com/articles/top-10- ... f-q1-gains

If you buy the cap-weighted market then you are betting that the biggest companies by capitalisation will be the best performers. Why else would you invest more in them.

Once you accept that you don't know where the big winners come from then equal weighting on purchase makes more sense. As long as you diversify widely enough to begin with you should be able to capture sufficient winners.

BoE

Bubblesofearth wrote:

AshleyW wrote:I think there have been many studies that show that the returns of all indices are dominated by a few companies and that the majority have lacklustre returns. It’s rather like what is said about university - you only use 2% of what you learn - it’s just a shame when you’re a student you can’t predict the 2%. So life for investors would be great if we could pick those super achieving winners. But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns.

Just to illustrate the point in Q1 2023 just 10 companies within the S&P 500 accounted for 90% of the gains. https://www.nasdaq.com/articles/top-10- ... f-q1-gains

If you buy the cap-weighted market then you are betting that the biggest companies by capitalisation will be the best performers. Why else would you invest more in them.

Once you accept that you don't know where the big winners come from then equal weighting on purchase makes more sense. As long as you diversify widely enough to begin with you should be able to capture sufficient winners.

BoE

If you are aiming purely for capital gains, then probably a selection of the low yielding shares will give you that result, but the fads and fashions can catch you out. The dot-com boom at the turn of the century was a classic example. Cryptocurrency is a recent fad.

However what is more probable is that investing in consistent performers will do the job. That consistency is in paying increasing dividends, having a growing cash flow, not being over exposed to debt, and being in a sector less vulnerable to events.

I like to quote the example of IMI, spun out of ICI in the 1980s and bought by me about 2010 at a price around 250p. Quite a high yield because it was oversold. It subsequently rose rapidly and dividends increased. Currently 1609p with a yield sub 2%. It's my best performing share. Despite the low yield, I have no plans to dispose of it.

TJH

Bubblesofearth wrote:

AshleyW wrote:I think there have been many studies that show that the returns of all indices are dominated by a few companies and that the majority have lacklustre returns. It’s rather like what is said about university - you only use 2% of what you learn - it’s just a shame when you’re a student you can’t predict the 2%. So life for investors would be great if we could pick those super achieving winners. But we can’t so most of us buy the market to make sure we don’t miss out on the winners that dominate market returns.

Just to illustrate the point in Q1 2023 just 10 companies within the S&P 500 accounted for 90% of the gains. https://www.nasdaq.com/articles/top-10- ... f-q1-gains

If you buy the cap-weighted market then you are betting that the biggest companies by capitalisation will be the best performers. Why else would you invest more in them.

Once you accept that you don't know where the big winners come from then equal weighting on purchase makes more sense. As long as you diversify widely enough to begin with you should be able to capture sufficient winners.

BoE

But the problem, for most, is that while the "equal-weight-and-leave-alone" strategy may do well (since it doesn't waste money in the churn of rebalancing), you can't do it by buying a tracker (since that will rebalance), and to diversify "widely enough", you need to buy a lot of individual shares at the start - which may be inefficient in terms of fees, unless you have a very big lump sum to invest. If you want to invest regularly, it doesn't really help at all - perhaps then your strategy could be "buy the same pound amount, of the next-biggest share you currently don't own". Or should you look at sectors, and make sure you're well spread between them? Or, if buying globally, well spread by country?

If you buy the cap-weighted market then you are betting that the biggest companies by capitalisation will be the best performers. Why else would you invest more in them.

Once you accept that you don't know where the big winners come from then equal weighting on purchase makes more sense. As long as you diversify widely enough to begin with you should be able to capture sufficient winners.

That has some logical appeal, but in a simplified outline how does one implement the strategy? The starting point is that there are about 10,000 tradable stocks globally.

JohnW wrote:

If you buy the cap-weighted market then you are betting that the biggest companies by capitalisation will be the best performers. Why else would you invest more in them.

Once you accept that you don't know where the big winners come from then equal weighting on purchase makes more sense. As long as you diversify widely enough to begin with you should be able to capture sufficient winners.

That has some logical appeal, but in a simplified outline how does one implement the strategy? The starting point is that there are about 10,000 tradable stocks globally.

How could a fund equal-weight all 10,000 of those shares? That would involve investing the same amount in both Apple and the smallest of those 10,000 shares. And that would totally distort the share price of the tiddlers, which are not liquid enough to take such a weight of money.

There is an equal-weight ETF for the S&P 500, ticker RSP. But most equal-weight ETFs seem to be sector funds, which can make sense where one company dominates a sector. I actually hold one for biotech companies, since it is a bit of a lottery which ones will develop a blockbuster new drug.

EthicsGradient wrote:But the problem, for most, is that while the "equal-weight-and-leave-alone" strategy may do well (since it doesn't waste money in the churn of rebalancing), you can't do it by buying a tracker (since that will rebalance), and to diversify "widely enough", you need to buy a lot of individual shares at the start - which may be inefficient in terms of fees, unless you have a very big lump sum to invest. If you want to invest regularly, it doesn't really help at all - perhaps then your strategy could be "buy the same pound amount, of the next-biggest share you currently don't own". Or should you look at sectors, and make sure you're well spread between them? Or, if buying globally, well spread by country?

Yes, you need to buy enough shares such that you can be confident of capturing some big winners. Probably 50-60 would be my estimate, ensuring good sectoral diversification. To keep dealing charges low these would need to be in blocks of at least £1500 so, yes again, you are looking at a substantial sum of money for this kind of investment approach.

Within reason I don't think it matters whether this is done in one lump sum or over time. Both ways you end up with the required portfolio. You just need to accept the 'over time' approach will likely experience more volatility until the final portfolio is reached.

BoE

It’s starting to sound like a stock picking active management approach to investing if 60 stocks will represent 10,000, rather than a ‘buy the market but do it equally’ approach. And the further it deviates from that the less the attractive theory is operating.
The S&P biotech equal weighted fund XBI seems to exclude Amgen, Gilead and Moderna, some of the biggest biotechs. It’s a misnomer to call a global cap weighted tracker with 3500 stocks ‘cap weighting the market’, but it seems a much bigger misrepresentation to call a fund equal weighted if it omits three of the biggest in the business.