Value Weighted Index
A Value Weighted Index weights stocks within the relevant universe based on a calculation of each stock's absolute and relative value as compared to the other stocks within the index universe. The index is continually rebalanced to weight most heavily those stocks that are priced at the largest discount to various measures of value. The index is updated as prices and company fundamentals change.
Advantages
- The index continually rebalances towards the cheapest stocks according to various measures of value, resulting in a portfolio that should benefit significantly from the pricing inefficiencies within the relevant universe over the long term.
- The index consists of a much more diversified portfolio than a market cap weighted index.
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Disadvantages
- The index is not as tax efficient as a market cap index as a result of a continual process of rebalancing towards value.
- The index may not outperform other indexes over shorter time periods.
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How to Calculate
- A true value weighted index should weight stocks in the portfolio based on how cheap they appear based on the selected value factors (as opposed to market cap), and rebalance the portfolio toward the cheapest stocks on a regular basis to account for changes in underlying fundamentals and stock price movements.
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