What is a market cap-weighted index?
Indexes constructed to measure the characteristics and performance of specific markets or asset classes are typically market cap-weighted, meaning the index constituents are weighted according to the total market cap or market value of their available outstanding shares.
In market cap-weighted indexes, a company’s representation within the index is based on its market value, and its performance contributes to the performance of the overall index proportionately.
In other words, the company with the largest market cap will represent the largest weight in the index, meaning mega cap companies will impact the performance of the overall index more than a small cap company will.
This method of weighting index constituents remains the most commonly used today. Despite the development of hundreds of alternatively-weighted indexes in recent years, market capweighted indexes remain relevant—as they reflect the primary characteristics of markets and so are used to understand fundamental changes in markets and market segments.
What does it mean for an index to be float adjusted?
There are a number of non-cap-weighted index construction approaches that complement traditional market cap-weighted indexes.
In alternatively-weighted indexes, constituent weights are determined independently of market value. These indexes are designed to target specific objectives such as reducing risk or improving diversification. Alternative weighting mechanisms include equally weighting index constituents and basing weights on fundamental criteria such as:
- cash dividend rates
- book value
What are factor indexes?
Academic research has long maintained that stock relative performance can largely be explained by several common characteristics such as:
- price momentum
Factor indexes are non-cap-weighted indexes that are designed to capture the performance of these characteristics. These indexes are intended to offer more focused exposures to factors than their market cap-weighted counterparts.
A factor index sets out to capture factor exposures in a controlled and considered way. Single factor indexes and factor combination indexes, which can be tailored depending on the desired exposures, are common solutions used by investors.
What are thematic indexes?
A thematic index is designed to follow a generally-accepted investment theme rather than a particular country, sector, or market segment. An example is an index comprised of companies listed in developed markets such as the UK and US that derive significant revenue from emerging markets.
The purpose of this investment strategy would be to gain exposure to emerging markets without directly purchasing stocks issued by companies listed in emerging market countries, hence avoiding the country and currency risks and higher trading costs associated with some emerging markets investments.
What is an index value?
Differences in how index values are calculated can occur depending on the index weighting scheme. For the sake of simplicity, we will explain the calculation of market cap-weighted index values.
As prices and market values of the stocks within an index rise and fall, the index reflects this movement using a series of index values. Index values are calculated and published daily after the market closes, and in some cases they are calculated in real time. The change in an index’s value from one point in time to the next represents the performance of the index (i.e., the performance of the market/segment it is designed to measure).
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