A convenient truth

There is growing consensus among scientists that global temperatures are warming, although sceptics remain.

The consensus in the investment world supporting market capitalisation indices as the basis for investment products is going in the other direction. The sceptics are rising.

While scientists struggle to develop cleaner technologies, smart investment managers are adopting simple but revolutionary methods to improve portfolio construction.

There is no easy answer for climate change. The answer for investment managers is here.

A number of recent academic and commercial studies conclude that equal weighting is the best performing index methodology.

Previously we highlighted that a study by the CSIRO/Monash¹, Australia’s national science agency in conjunction with the Monash Superannuation Research Cluster, found equal weighting is the "highest performing" structure for a portfolio, better than one based on market capitalisation and better than "fundamental indexation."

The research concluded that equally weighting a portfolio results in outperformance versus market capitalisation weighting due to 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.

The CSIRO/Monash research supports earlier conclusions made by the University of London’s Cass Business School, which demonstrated the inefficiency of market capitalisation indices in a comprehensive study which analysed 10 million randomly created portfolios versus a market capitalisation weighted index². The alternate indices considered by Cass, including equal weight, “would have produced a better risk-adjusted performance than could have been achieved by having a passive exposure to a market-capitalisation weighted index.”

S&P Dow Jones also found that equal weight indexing was a harder to beat reference point in its white paper “Equal-Weight Benchmarking: Raising the Monkey Bars”³.

The scientific theory and research supports equal weight indexing. Market Vectors has launched the only Australian fund that tracks an equal weight index, the Market Vectors Australian Equal Weight ETF (ASX code: MVW).

As with all challenges to the consensus, there are deniers. Those who have been made comfortable by the current regime argue against the new order.

The conservatives raise liquidity concerns with equal weight indices. They argue that smaller stocks make the underlying portfolio illiquid. The index MVW tracks (MVMVWTRG Index) dispels this concern by applying a series of strict liquidity screens. Illiquid stocks are not included. As a result, MVW holds 74 of the largest and most liquid companies on the ASX.

Another myth asserted against equal weight indices is that equal weighting has high turnover. In analysing the MVMVW TRG Index we found that the turnover is well within acceptable ranges.

The theory and research supports equal weight. In practice too, equal weighting demonstrates outperformance. Since its launch on the ASX in March this year MVW has achieved higher performance than the standard Australian S&P/ASX 200 market capitalisation index. We are able to demonstrate long term performance after management costs too.

To analyse the long term performance of our equal weight indexing methodology we have taken the performance of the MVMVWTRG Index and adjusted it for the impact of management costs of 0.35% p.a.

† S&P/ASX Indices are unmanaged and do not include fees and costs payable when investing in a fund.
# Results are calculated to the last business day of the month and assume immediate reinvestment of distributions and include MVW’s management costs of 0.35% p.a. MVW Index was launched on 29/11/2013. MVW commenced operation on 4/3/14. MVW Index performance shown prior to its launch date is simulated based on the current index methodology.

Over each long term period (after hypothetical fees) illustrated above, the MVMVWTRG Index produced superior performance to the standard Australian market capitalisation index.

This performance also compares favourably to the median and mean of Australian equity fund managers in Morningstar’s Large Growth Universe, Large Value Universe and Large Blend Universe.

These tables also highlight the difficultly active managers have achieving returns higher than the standard Australian market index over the long term.

Source: Morningstar Direct, as at 31 July 2014.

Source: Morningstar Direct, as at 31 July 2014.

Source: Morningstar Direct, as at 31 July 2014.
* Fund manager performance figures are net of fees
† S&P/ASX Indices are unmanaged and do not include fees and costs payable when investing in a fund.
# Results are calculated to the last business day of the month and assume immediate reinvestment of distributions and include MVW’s management costs of 0.35% p.a. MVW Index (MVMVWTRG) was launched on 29/11/2013. MVW commenced operation on 4/3/14. MVW Index performance shown prior to its launch date is simulated based on the current index methodology.
Australian Equity Large Blend, Large Growth and Large Value Universe is based on the defined universe funds that invest primarily in large Australian companies. Stocks in the top 70% of the Australian equities market based on market cap are defined as ‘large’. The ‘blend’ style is assigned to portfolios where neither growth nor value characteristics dominate.

The practical experience supports the case for equal weight.

The theory supports the case for equal weight.

You can make up your own mind about global warming but we invite you to join the move to equal weight indexing.

Market Vectors Australian Equal Weight ETF is the only ETF in Australia that offers a broad-based equally-weighted Australian equities portfolio. It trades on the ASX under the ticker MVW and is an ideal tool for constructing an Australian equities portfolio. It is liquid and cost effective and gives you instant diversification via a single trade.

If you would like to speak to one of our ETF specialists email us at info@marketvectors.com.au or call 02 8038 3300.

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 product disclosure statement (PDS) and consider if the decision is appropriate for your circumstances. A copy of the PDS is available at http://www.marketvectors.com.au/.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.

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.

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¹CSIRO‐Monash Superannuation Research Cluster Is fundamental indexation able to time the market? Evidence from the Dow Jones Industrial Average, Paul Lajbcygiera, Doris Chen, Michael Dempsey, November 2013.

²Cass Business School An evaluation of alternative equity indices Part 1: Heuristic and optimised weighting schemes Andrew Clare, Nick Motson and Steve Thomas, March 2013

³ S&P Dow Jones Indices Equal-Weight Benchmarking: Raising the Monkey Bars Tim Edwards, Craig J Lazzara, June 2014