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This paper* compares classic and new smart-beta indices that are designed to capture the value premium. Classic value indices segment the market into value and growth stocks, and then apply capitalization weighting to the value segment of the market.
The study observes that the first such indices were already introduced around twenty years ago, but have since failed to outperform the market in the US. Fundamentally weighted indices, on the other hand, have succeeded in capturing the value premium. The author attributes this to the use of a more effective rebalancing mechanism. We wonder if this may also be related to the strong dependence of capitalization-weighted indices on the performance of just a few of the very largest stocks. Publicly available data for value strategies provided by Professor Kenneth French shows that cap-weighted value strategies have failed to outperform the large-cap segment of the US market. However, this same data also demonstrates that, when not inhibited by cap-weighting restrictions, on average, value stocks have outperformed growth stocks by a solid margin.
*Hsu, “Value Investing: Smart Beta versus Style Indices”, Journal of Index Investing, 5 (2014), pp. 121-126.