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A comparison between capitalization-weighted and equally weighted indexes in the European equity market

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Abstract

This article aims at comparing two major equity index construction methodologies, the capitalization-weighted and the equally weighted approaches. Focusing on the constituents of the DJ Euro Stoxx index from January 2002 to December 2011, it provides further evidence to add to the established literature on this topic, of the higher risk-adjusted returns achieved by equally weighted portfolios in comparison with cap-weighted indexes. The novelty of our study is that we test these findings on the Euro stock market by using four reweighting frequencies (monthly, quarterly, semiannually and annually) with the aim of identifying that which is most able to maximize the benefits of the contrarian strategy implicit in the equally weighted approach. Moreover, it is demonstrated that the excess returns are not driven solely by a ‘size effect’ that usually explains the difference in performance of the two methodologies. Finally, we confirm our results by performing a Fama-French (1992) three-factor regression analysis and also by using a portfolio approach based on the market capitalization of the index constituents. To evaluate the implementation of the EW strategy, from an operational perspective, we estimate the related transaction costs and show that trading costs are not able to affect the main results.

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Notes

  1. See Swinkels (2004) for a survey on momentum investing.

  2. European data are also used by Hemminki and Puttonen (2008) in their study on the benefits of fundamental indexation.

  3. According to the statistics provided by Blackrock, in 2011, the market share of the IShares products in Europe, within the category of ETFs, was 70 per cent. Moreover, in December 2011, the assets under management by the IShares in Europe were €105.9 billion.

  4. The DJ EuroStoxx and the DJ EuroStoxx 50 are composed only of stocks denominated in euro. This restriction allows a comparison of the two index construction methodologies without having to consider the trend of the exchange rates (primarily the EUR/GBP).

  5. A negotiation fee equal to 10 bps for stock trading is relatively high for institutional investors. Our conservative assumption allows considering the possible additional transaction costs arising from the bid-ask spread characterizing smaller cap stocks.

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Authors and Affiliations

  1. Department of Economics and Statistics, University of Udine, Via Tomadini 30/A I, Udine (UD) 33100, Italy

    Enrica Bolognesi

Authors
  1. Enrica Bolognesi
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  2. Giuseppe Torluccio
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  3. Andrea Zuccheri
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Correspondence to Enrica Bolognesi.

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Disclaimer STOXX Limited (‘STOXX’) is the source of Dow Jones EuroStoxx Index and the Dow Jones EuroStoxx 50 Index and STOXX or its third-party data providers are the source of the data comprised therein. STOXX has authorized the publication of a limited amount of index data in the doctoral of Enrica Bolognesi, Giuseppe Torluccio and Andrea Zuccheri published in the Journal of Asset Management. Any dissemination or further distribution of such information is prohibited. Neither STOXX nor its third-party data providers have been involved in any way in the creation of any reported information and they neither warrant nor assume any liability whatsoever – including without limitation the accuracy, adequateness, correctness, completeness, timeliness and fitness for any purpose – with respect to any reported information.

Although the article is the result of a joint effort, Section ‘Data and Methodology’ was provided by Enrica Bolognesi; Section ‘Conclusions’ was provided by G. Torluccio; Sections ‘Introduction’ and ‘Empirical Results’ was provided by Andrea Zuccheri.

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Bolognesi, E., Torluccio, G. & Zuccheri, A. A comparison between capitalization-weighted and equally weighted indexes in the European equity market. J Asset Manag 14, 14–26 (2013). https://doi.org/10.1057/jam.2013.1

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  • DOI: https://doi.org/10.1057/jam.2013.1

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