Should most investors beat the market?

IronWolf

Just over 10 years ago the S&P 500 equal weight index was launched, since then it has returned 10.2% a year compared to the normal S&P 500 (market cap weighted) of 7.1% a year [ source]. It also won over 20 years, however not on a "risk adjusted" basis.

I have run backtests on this kind of thing myself, and the evidence is compelling that equally weighted portfolios consistently beat their benchmark indices.

Considering that investor wisdom now seems to be steering towards 'invest in low cost index trackers' I think it is interesting, because research suggests that individual investors have an inherent advantage over indexes - they dont have to weight by market cap.

To test the theory a research company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year from 1964 to 2010, and tracked the results. Amazingly, on average, 98 of the 100 portfolios beat the 1,000 stock capitalization weighted stock universe each year.

ChesterDog

There are trackers for tracking equal-weighted indicies aren't there? But I don't think there are many. Very interesting research and result.

SailorSam

ChesterDog wrote: »

I think I must have banged my head.

Edit: After that spam is removed, my comment is going to look pretty strange. :-)

I don't think you get a lot of spam on here from people who have been members of Mse for 4yrs and have a posting history of over 3000.

Archi_Bald

SailorSam wrote: »

I don't think you get a lot of spam on here from people who have been members of Mse for 4yrs and have a posting history of over 3000.

You missed the real spam, which has now been removed. Something about voodoos and chicken dances and miraculous repairs of screwed up lives. From a one post wonder.

SailorSam

Archi_Bald wrote: »

You missed the real spam, which has now been removed. Something about voodoos and chicken dances and miraculous repairs of screwed up lives. From a one post wonder.

Sorry, i thought ChesterDog was trying to say the Op couldn't have made money from his investments.

ChesterDog

Funnily enough, while I was away eating, I was pondering that very thought: that the greater return is probably/possibly simply a reflection of slightly increased risk.

Thrugelmir

IronWolf wrote: »

I have run backtests on this kind of thing myself, and the evidence is compelling that equally weighted portfolios consistently beat their benchmark indices.

I've never weighted my share holdings by market cap. As market cap in itself has no investment significance.

gadgetmind

The advantage of cap weighting is that you need do nothing to maintain your chosen weighting - if a company's share price doubles, you hold twice as much while doing nothing.

How do you keep an equal weighting portfolio at equal weighting? Some say that you shouldn't even try, others set company/sector limits, theories abound, argument are had, at length.

Meanwhile, market cap is there, easy and accessible for pretty much any market.

As it happens, I use market cap trackers for most of my investments but have a UK dividend income portfolio that's equal cap weighted. Sort of. That I tinker with. Perhaps too much.

Anyway, all very interesting, but how do we tweak our investment portfolios in the light of all of this?

payless

IronWolf wrote: »

To test the theory a research company randomly selected 100 portfolios containing 30 stocks from a 1,000 stock universe. They repeated this processes every year from 1964 to 2010, and tracked the results. Amazingly, on average, 98 of the 100 portfolios beat the 1,000 stock capitalization weighted stock universe each year.

Do you have a link or source for this ? 98/100 seems high for this type of study.

Were the 30 stocks in each portfolio were random, is this US data only.

So if using 1000 stocks that means we are looking some at smaller cap.

I would be interested in whether we are looks at cap gains or total return, and if any survivor bias.

BillJones

This seems unlikely enough that it has to be a mathematical error. I wonder if total return versus price return is being used, for example.

Also, it's worth pointing out, not all indices are market cap weights. The Dow is price weighed, for example.

Ah, I see someone pointed out that it's offset by risk-weighted measures, so is a trivial result, and no good for increasing returns.

IronWolf

beancurd wrote: »

If only.

Rick Ferri covered this in a recent blog post better than I could hope to.

http://www.rickferri.com/blog/investments/beat-the-sp-500-with-the-sp-500/

There’s more risk in an equal-weighted S&P 500 stock strategy. Once the extra risk is accounted for, the strategy is a zero-sum game.

It isn't amazing, it's natural.

But academics definition of risk is just volatility, it isnt real risk at all. People in the city care about volatility because they have short sighted sheeple as investors. For those of us investing privately, volatility is not risk and equal weighting clearly gives individuals an edge.

This is the research I mentioned http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2165563