In Defence of Capitalisation Weights: Evidence from the Ftse 100 Index 1984-2004

Abstract

Capitalisation weighting has added 8,000 basis points of incremental returns to the FTSE 100 Index compared to an equally weighted portfolio of the same constituents. Industry factors explained 66% of the incremental returns, while size and style factors explained 2%. The capitalisation weighted index volatility was lower than the equally weighted counterpart during negative tail events in the return distribution. Diversification benefits have arisen because the biggest firms either had above average returns or below average covariance, compared to the rest of the portfolio constituents.

Keywords: FTSE 100 Index, Benchmark-portfolios, capitalisation weights stock-indexes, portfolio-diversification, performance-measurement

JEL Classification: G10, G11, G12, G14, C63, L11