Talk About Stock Index Funds (2)

There are so many different indices, which one is better?

After considering the pros and cons of the different indexing methods mentioned above, I have concluded that a market capitalization-weighted index is currently the most appropriate Investors invest in indices used by the stock market. There are several reasons for this.

(1) The GDP-weighted index does not take into account the liquidity of each country's stock market. For example, as of December 31, 2015, at an exchange rate of 6.498 RMB to USD, the total Chinese A-share The market capitalization was $7.1059 trillion, or about 68% of GDP (in terms of GDP of $10.41 trillion). The total market capitalization of U.S. equities over the same period was $23.8233 trillion, or about 133% of GDP (in terms of ($17.87 trillion in GDP).

Weighted by GDP, a world equity index needs to include a very large number of Chinese A shares. But from the perspective of a global dollar investor, the number of Chinese stocks he can buy in free float is very limited, mainly because of The renminbi is not yet fully free to move across borders. Therefore it is somewhat unreasonable to ask investors to track such a GDP-weighted global equity index.

(2) A market capitalization-weighted index does not require frequent weighting adjustments like an equal-weighted index, thus saving more transaction costs and giving investors higher returns.

(3) The vast majority of financial research is based on market capitalization-weighted indices, the rationality of which is supported by some of the more accepted financial theories, such as efficient market theory and capital asset pricing models.

(4) Market capitalization-weighted indices are also the benchmarks used by the vast majority of financial institutions today. Because everyone uses such benchmarks, index funds that track market capitalization-weighted indices are the most numerous, least expensive and most liquid. and has maximum selectivity for investors.

(5) There is no theoretical limit to the number of holdings in a market capitalization-weighted index. This is because the larger the market capitalization of a company in a market capitalization-weighted index, the greater the weighting of the company. The index itself is the market, so regardless of whether an investor has $100 million, $1 billion, or $10 billion, there is no limit to the amount of money that can be invested and held in a market capitalization-weighted index. There is no size limit when weighting index funds.

(6) Market capitalization-weighted indexes are less complex to calculate and easier to replicate, so such indexes are easier to manage for index fund managers and their Tracking Difference (TDI) will be smaller.

At the end of 2015, of the listed liquid stocks available to investors in this world, U.S. stocks accounted for about About half of the world's total stock market capitalization. The U.S. accounts for about 17% of the world's GDP, so from a financial investment perspective, the percentage of U.S. equity market capitalization is very high The.

After the United States the big stock countries are Japan, the United Kingdom, France and Germany. China (Hong Kong) accounts for about 2% of the world's stock market capitalization. With the internationalization of the renminbi and the continued opening of China's financial markets, the share of Chinese stocks in the pie chart above will be It's getting bigger.

Of course, market capitalization-weighted indices are not perfect. Criticisms of market capitalization-weighted indices generally include the following.

(1) Market capitalization-weighted indexes look only at market capitalization when assigning weightings to members of the index, ignoring their "intrinsic" or "fundamental" value. . The more overvalued a stock is in a market cap-weighted index, the higher its market cap and the higher its weighting. For example, when the Internet bubble was at its peak in 1999, the most overvalued technology stocks received a weighting in the index of Highest. This did not make sense to some investors.

(2) One of the theoretical foundations for the rationality of market capitalization-weighted indices is the "efficient market theory", i.e. "price is right". The debate on efficient market theory never ends and if we look back in history, we can easily conclude that markets sometimes don't work as well as they should. "Efficient". Of course, the efficient market theory never says that the market is always efficient, which should be a misunderstanding of the efficient market theory by many people. But anyway, if markets are always "ineffective", then there will be times when an index based on market capitalization weighting is not properly valued. .

(3) If we break down the risk factor of the market capitalization-weighted index a little deeper, we can conclude that the market capitalization-weighted index is affected by the momentum ( (Momentum) and Size factors are more influential. As an example, the S&P 500 selects the 500 largest companies in the United States by market capitalization. In the same way that the S&P index selects companies, the companies selected by the S&P 500 are either large stocks (Size Factor) or Stocks that are rising faster in price (momentum factor). And the larger they are, the faster their price rises and the greater their weight in the index. So at the risk factor level, a market capitalization-weighted index like the S&P 500 would not include small stocks and would have a large weighting in its The index is underweighted to value stocks, thereby potentially affecting investor returns.

(4) Market capitalization-weighted indexes can sometimes have a severe industry bias. For example, prior to the bursting of the technology stock bubble in 1999, the index was very heavily weighted to the technology and telecommunications sectors. 2007 Prior to the financial crisis, the index had a very high weighting in banking stocks. Market capitalization-weighted indices reflect the rise and fall of different industry cycles and amplify them.

There is no perfect way to select an index. As investors, we can only choose the most appropriate index by compromising and making trade-offs after considering a variety of different factors. After taking into account all the pros and cons, I believe that the market capitalization weighted index is the most suitable equity index for a wide range of investors.

I hope this will help you.