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Essays on Alternative Weighting Schemes for Active Equity Indexes

By definition, cap-weighted indexes place the largest (smallest) weights on the most overvalued (undervalued) securities. Fundamental indexation has recently been proposed as a passive, low-cost strategy that outperforms classical cap-weighted indexes. This dissertation focuses on new alternative weighting schemes based on fundamental indexation and analyzes underlying forces that drive their outperformance.
The first essay proposes an alternative weighting strategy based on enterprise-value multiple (EM). Over the period 19722013, the EM-weighted index (Details of the weighting scheme can be referred to appendix) has the lowest tracking error and the highest information ratio when compared with six fundamental-weighted indexes based on book-equity (BE), earnings (E), sales (S), dividends (D), cash-flow (CF) and EBITDA. The EM-weighted index generates an information ratio of 0.73, 35% larger than that of the composite of the fundamental indexes. Further results show that it is the combination of the market information and firms fundamentals, especially the debt information, that drives the outperformance of the EM-weighted index.
The second essay is the first to demonstrate that outperformance of smart beta strategies can come from capturing diversification returns embedded in portfolio rebalancing of the strategies. This is different from the traditional argument that outperformance of smart beta strategies is due to their implicit tiling into different risk factors such as value and size. A 3X3 matrix of different weighting schemes is constructed to investigate this phenomenon, which combines market capitalization, equal, and fundamental weighting schemes into two levels - first it is weighted on an industry level and then weighted on a stock level within its specific industry. Results show that the diversification returns can consistently explain outperformance of alternative weighting schemes in the matrix, and it is not subsumed by factors in different asset pricing models. This suggests that when measuring the performance of smart beta strategies, not only should investors pay attention to the factor tiling of these strategies but also be cautious about diversification returns captured by rebalancing embedded in these strategies.
Date12 April 2016
CreatorsLin, Wenguang
ContributorsGary, Sanger, Pace, Kelly, Wang, Junbo, Mo, Haitao, Newman, Robert, McCarter, Kevin
Source SetsLouisiana State University
Detected LanguageEnglish
Rightsrestricted, I hereby certify that, if appropriate, I have obtained and attached herein a written permission statement from the owner(s) of each third party copyrighted matter to be included in my thesis, dissertation, or project report, allowing distribution as specified below. I certify that the version I submitted is the same as that approved by my advisory committee. I hereby grant to LSU or its agents the non-exclusive license to archive and make accessible, under the conditions specified below and in appropriate University policies, my thesis, dissertation, or project report in whole or in part in all forms of media, now or hereafter known. I retain all other ownership rights to the copyright of the thesis, dissertation or project report. I also retain the right to use in future works (such as articles or books) all or part of this thesis, dissertation, or project report.

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