When Does Capitalization-Weighting Outperform? Factor-Based Explanations

Posted: 11 May 2018 Last revised: 22 May 2019

See all articles by Roger G Clarke

Roger G Clarke

Ensign Peak Advisors

Harindra de Silva

Analytic Investors, Inc.

Steven Thorley

BYU Marriott School of Business

Date Written: July 13, 2018

Abstract

Some of the market-relative performance of U.S. stock mutual funds can be explained by the pure returns to now commonly accepted equity market factors. Historically, managers in the aggregate have had more equally-weighted positions than the capitalization-weighted portfolio to which they are typically compared. Currently, the active returns of mutual funds are positively associated with the performance of the Momentum and Profitability factors, and negatively associated with the performance of the Value and Low Beta factors. These effects are particularly strong in mutual funds with a stated “growth” objective. Thus, capitalization-weighted indexes outperform active managers most of the time, but especially when the Value and Low Beta factors have high returns, and the Momentum and Profitability factors have low returns.

Keywords: indexing, factor investing, mutual fund performance, passive investing

JEL Classification: G11

Suggested Citation

Clarke, Roger G and de Silva, Harindra and Thorley, Steven, When Does Capitalization-Weighting Outperform? Factor-Based Explanations (July 13, 2018). https://doi.org/10.3905/pa.6.3.300. Available at SSRN: https://ssrn.com/abstract=3172498 or http://dx.doi.org/10.2139/ssrn.3172498

Roger G Clarke

Ensign Peak Advisors ( email )

60 East South Temple
4th Floor
Salt Lake City, UT 84111
United States

Harindra De Silva

Analytic Investors, Inc. ( email )

555 West 5th Street
50th Floor
Los Angeles, CA 90013
United States
213-688-3015 (Phone)
213-688-8856 (Fax)

Steven Thorley (Contact Author)

BYU Marriott School of Business ( email )

616 TNRB
Brigham Young University
Provo, UT 84602
United States
801-378-6065 (Phone)
801-378-5984 (Fax)

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