Index weighting determines how much weight each constituent security will be assigned in the index, thereby impacting the index value. The different weighting schemes used in construction of an index are:
Price weighted index: weight on each security is determined by dividing its price by the sum of all prices.
Equal weighted index: assigns equal weight to each constituent security at inception.
Market capitalization weighted index: weight of each security is determined by dividing its market capitalization with total market capitalization.
Fundamental weighted index: instead of using a stock’s price as a measure, fundamental weighting uses measures such as book value, cash flow, revenue, earnings and dividends to calculate the weight of each security.
|Equal||Simple||High market cap stocks are under-represented. Requires frequent rebalancing.|
|Market Cap||Securities held in
proportion to their value.
|Influenced by overpriced securities.|
|Fundamental||Value tilt||Does not consider market value. Requires rebalancing.|