What Drives the Performance of Efficient Indices?

Capitalisation-weighted indices are known to suffer from problems associated with high concentration; they fail to take full advantage of the diversification opportunities offered by equity markets.

Auteur(s) :

Felix Goltz

Head of applied research at EDHEC-Risk Institute and directorof research and development at EDHEC-Risk Indices & Benchmarks.

Dev Sahoo

Quantitative analyst at EDHEC-Risk Institute.

Présentation :

Efficient indices draw on portfolio construction techniques to provide risk/return tradeoffs better than those of their cap-weighted counterparts. Efficient indices provide significant improvements of risk/return properties across different regions and various economic and market conditions. This paper, then, provides a detailed comparison of the performance of efficient indices and that of the respective cap-weighted indices to account for the sources of this outperformance. The efficient index is built on the concept of finding a proxy for the tangency portfolio by maximising the Sharpe ratio, and better diversification is a major contributor to the performance of efficient indexation. Efficient indices are at their best when market conditions reward optimal diversification strategies, that is, when cap-weighted indices tend to be most heavily concentrated and when correlations are stable. In addition, we look at the way sector performance contributes to the overall performance of both efficient and cap-weighted indices. Unlike that of the cap-weighted index, the performance of efficient indices is driven more by better diversification across stocks than by shifts in sector weights. Finally, an analysis of the equity risk factor exposures for both efficient and cap-weighted indices confirms thatthough exposures of efficient indices are obviously different from those of cap-weighted indicesthe performance of efficient indices cannot be explained entirely by simple factor tilts. On the whole, our results suggest that improved diversification is a key source of the outperformance of efficient indexing.
Pdf
What Drives the Performance of Efficient Indices?...
(3.97 MB)
Type : Publication EDHEC
Date : le 28/04/2011
Complément d'informations For more information, please contact Joanne Finlay, EDHEC Research and Development Department [ joanne.finlay@edhec.edu ] The contents of this paper do not necessarily reflect the opinions of EDHEC Business School.
Pôle de recherche Marketing

A voir également

- 22-04-2017
Nicolas Hulot, portant la double casquette de reporter-journaliste et d’homme politique, est pleinement engagé dans ses actions en faveur d’une prise de conscience du risque écologique....
Les Entretiens de Nice : Questions d'Education
- 12-04-2017
Le Pôle de recherche en économie poursuit ses conférences dans la cadre du second cycle...
- 04-04-2017
En 2017, l’EDHEC se distingue de nouveau comme l’école de commerce française ayant obtenu le plus de « A », avec une mention spéciale pour son excellence de l’enseignement (quatre...
Frédéric Oudéa, Directeur général de la Société Générale à la rencontre des étudiants de l’EDHEC
- 31-03-2017
La Société Générale est l'une des 3 banques du CAC 40. Son Directeur général a choisi,...