Global Stock Indexes
Stock indexes are a key way to describe a market and compare different investments. Investors can gain exposure to international markets by investing in mutual funds or exchange-traded funds (ETFs) that track a specific global index.
Global indices can be weighted by a variety of factors, including market capitalization. They also can be sector based, price-weighted or dividend-weighted.
Market Cap Weighting
Market cap weighting is one of the most common methods of weighting stock indexes. It reflects the consensus estimate of each company’s value at any given moment, via the change in its market capitalization.
In a cap-weighted index, the largest companies have the biggest weighting. However, this method is not perfect and can lead to distorted outcomes.
The problem with market cap weighting is that it tends to overvalue equities in some markets, particularly those trading at a high price-to-earnings (PE) multiple. This can be a disadvantage for investors with equity investments in high PE markets, because it means they may have more exposure to companies that are underperforming relative to their peers.
To address this, float adjusted market cap weighting is now used by index providers like MSCI and FTSE. This weighting takes account of investibility and free-float – the number of publicly owned shares available to be traded.
Sector weighting can be a significant component of an equity portfolio’s performance. Whether an investor is overweight or underweight a specific sector can be influenced by a number of factors, such as global macro events, economic cycles and market momentum.
Many investors believe that a well-diversified portfolio should include all of the major sectors in order to reduce risk and maximize returns. This belief has been supported by long-term research on sector returns and business cycles.
However, this strategy has several disadvantages. For one, sector ETFs don’t benefit from inter-sector rebalancing like an equal weight S&P 500 fund does.
A price-weighted index (PWI) is a stock market index that gives more weight to stocks with higher prices. The biggest example of a price-weighted index is the Dow Jones Industrial Average.
In a PWI, the share prices of individual companies are weighted by the number of shares they represent in the index basket. This divisor is adjusted for consistency in case of stock splits or changes in the index list.
An unweighted index, on the other hand, has no explicit weighting. The index is based on the total number of shares and prices of all companies.
When comparing global stock indexes, it is important to consider how the constituents are weighted in each. This can have a significant impact on how the index performs.
Dividend Weighting is a form of index construction that is designed to enhance the performance of dividend-paying stocks by incorporating them into global stock indexes. This methodology is often used in exchange-traded funds (ETFs).
Dividend-weighted indices are available from several well-known providers, including Dow Jones, S&P, MSCI, Mergent (formerly Indxis), and Wisdom Tree. These indexes generally screen and weigh securities based on dividend yield or dividend growth and can include momentum filters.
Dividend weighted strategies have a strong track record of outperforming market capitalization-weighted strategies over the long term. They can also help to preserve investors’ capital during inflationary periods because of their emphasis on dividends and value characteristics.