Scientific Beta

This paper analyses a set of equity indices whose aim is to improve on capitalisation weighting and thus to provide “improved beta”. Four main weighting schemes are analysed: efficient indices, fundamental indices, minimum-volatility indices, and equal-weighted indices. Empirical results for US and Developed World data on these indices show that the average returns of all four alternative index construction methods are superior to those of cap-weighted equity indices in both universes and that, by several measures of risk-adjusted performance, they are likewise superior.

This paper analyses a set of equity indices whose aim is to improve on capitalisation weighting and thus to provide “improved beta”. Four main weighting schemes are analysed: efficient indices, fundamental indices, minimum-volatility indices, and equal-weighted indices. Empirical results for US and Developed World data on these indices show that the average returns of all four alternative index construction methods are superior to those of cap-weighted equity indices in both universes and that, by several measures of risk-adjusted performance, they are likewise superior. 

The paper also analyses factor exposures of alternative weighting schemes. Only the fundamental index has a value exposure that is substantially greater than that of the equal-weighted index. Other non-cap-weighted indices such as efficient indexation and minimum volatility have value exposures that are comparable to that of equal weighting. Since the indices studied here are made up of large-cap stocks, none of these indices shows any economically meaningful bias towards small caps. Interestingly, the minimum-volatility index, similar to the cap-weighted indices, shows a negative small-cap exposure since it favours the largest stocks.

A revisited version of this paper was published in the January/February 2011 issue of the Journal of Indexes.