Scientific Beta

While an ever increasing share of equity assets is invested in indexing strategies, the standard practice of using capitalisation weighting to construct stock market indices has been the object of much criticism. In response to this criticism, equity indices with different weighting schemes have emerged. Some indices use "fundamental" metrics (Arnott, Hsu, and Moore 2005) to weight the component stocks. In recent years, the market for such characteristics-based indices has grown tremendously, with more and more providers launching and offering them. 

While an ever increasing share of equity assets is invested in indexing strategies, the standard practice of using capitalisation weighting to construct stock market indices has been the object of much criticism.¹ In response to this criticism, equity indices with different weighting schemes have emerged. Some indices use "fundamental" metrics (Arnott, Hsu, and Moore 2005) to weight the component stocks. In recent years, the market for such characteristics-based indices has grown tremendously, with more and more providers launching and offering them. Institutional investors have allocated significant amounts to these alternatives to value-weighted indices. Likewise, a wide range of exchange-traded funds on these new indices is now available. 

Whether or not characteristics-based indices perform better than capitalisation-weighted indices is, ultimately, an empirical question. While the different providers assess the performance of their own indices, no extensive assessment or comparison involving indices from different providers has been done so far. EDHEC has studied the risk and return properties of these new indices, using an extensive database of 14 characteristics-based indices that are calculated by seven different providers.