How would a scientist build an investment portfolio?
The CSIRO is Australia’s national science agency and is one of the largest and most diverse research agencies in the world. It is so diverse that it is now directing resources to investment portfolio construction...
The CSIRO-Monash Superannuation Research Cluster is researching many aspects of our superannuation system including investment practices. A recent paper concluded that equal weighting is the “highest performing” structure for a portfolio, better than market capitalisation and better than RAFI’s ‘fundamental indexation.’
The paper tests United States data for the years 1962 to 2009. United States data is used because it encompasses the largest reliable data set available.
The results are that investing $1 in 1962 would grow to:
- $100.86 in an equally weighted portfolio;
- $87.28 in a fundamental indexation portfolio; and only
- $59.04 in a market capitalisation portfolio.
Sophisticated models developed by such finance luminaries as Nobel Prize winning economist Eugene Fama and Robert Merton were used to determine the source of this outperformance.
The conclusion is that equally weighting a portfolio outperforms market capitalisation because of three factors:
- higher exposure to smaller stocks rather than to bigger stocks;
- higher exposure to so-called ‘value stocks,’ meaning those stocks with a high book-to-market ratio; and
- better market timing.
What the paper means by market timing is that equal weighting extracts more return when markets are rising and loses less when markets are falling.
Equal weighting was found to outperform fundamental indexation because of the better market timing. This is contrary to the claims made by the proponents of fundamental indexing.
Fundamental indexing is promoted as being superior to market capitalisation on the basis that it uses better measures of the size of a company. Market capitalisation is based on traded prices and so is distorted when the market misprices. Fundamental indexing uses data such as book value, revenue, cash flow, dividends, sales and employee numbers to get a less-market-distorted quantifiable-size-based weighting.
The resulting index is said therefore to be less susceptible to market sentiment and extreme market phases such as bubbles. The CSIRO have shown equal weighting achieves this but that fundamental indexation does not.
In non-scientific terms, the problem with investing more in bigger companies and less in smaller companies is twofold. When the market overvalues a stock, you buy too much of the overpriced stock. When the market undervalues a stock, you sell too much of the underpriced stock.
Market Vectors Australian Equal Weight ETF is the only ETF that offers a broad-based equally-weighted Australian equities portfolio. It trades on the ASX under the ticker MVW (IRESS: MVW.AX).
MVW tracks the Market Vectors Australia Equal Weight Index. This is a pure-play rules-based index that consists of the most liquid ASX-listed companies across all sectors, including offshore companies that generate at least 50% of their revenues or assets from the Australian market.
For those who would like to read more, here is a link to the CSIRO paper:
Important Notice: This information is issued by Market Vectors Investments Limited ABN 22 146 596 116 AFSL 416755 as responsible entity and issuer of Market Vectors Australian Equal Weight ETF (MVW) (‘Market Vectors’) and is general in nature and does not take into account any person’s individual objectives, financial situation or needs (‘circumstances’). Before making an investment decision you should read the relevant product disclosure statement (PDS) and consider if it is appropriate for your circumstances. A copy of the PDS is available at www.marketvectors-australia.com or by calling the registry on 1300 MV ETFS (1300 68 3837).MVW is subject to investment risk, including possible delays in repayment and loss of capital invested. No member of the Van Eck Global group guarantees the repayment of capital, the performance, or any particular rate of return from MVW.
Hyperlinks to other websites or materials prepared by third-parties (links) are included as a convenience only. Market Vectors assumes no liability for the content of any linked websites and materials prepared by third-parties, including, without limitation, the accuracy, subject matter, quality or timeliness of the content of such linked websites or materials. The fact that such links have been provided does not constitute an endorsement, authorization, sponsorship by or affiliation with Market Vectors with respect to any linked website or material or their sponsor or author. Market Vectors is not liable for any harm caused by the transmission, through access of other websites, of a computer virus, or other computer code or programming device that might be used to access, delete, damage, disable, disrupt or otherwise impede the operation of the website or of any user's software, hardware, data or property.
The Market Vectors Australia Equal Weight Index (‘Index’) is the exclusive property of MVIS. MVIS has contracted with Solactive AG (“Solactive”) to maintain and calculate the Index. Neither MVIS nor Solactive sponsor, endorse or sell any financial products to which MVIS licenses the Index. MVIS and Solactive make no representation regarding the advisability of investing in any financial products based on MVIS’ indices. Solactive uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MVIS, Solactive has no obligation to point out errors in the Index to third parties.
MVIS and MVIL are wholly owned subsidiaries of Van Eck Associates Corporation based in New York (‘Van Eck Global’). Market Vectors® and Van Eck® are registered trademarks of Van Eck Global.
© 2014 Market Vectors Australia Pty Ltd. All rights reserved.