Monkeys vs Fund managers - An evaluation of alternative equity indices
A research collaboration between Aon Hewitt and Cass Business School has shown that alternative weighted indices offer better investment strategies than those of the market capitalisation index. Indeed, a computer simulation of random stock-picking, likened to the decision making of a monkey, outperformed a traditional market capitalisation weighted index every time.
This research was covered in the 4 April edition of City A.M. The headline "Monkeys trump fund managers" refers to the research findings that a computer simulation of random stock-picking, likened to the decision making of a monkey, outperformed a traditional market capitalisation weighted index every time.
Last summer Aon Hewitt and Cass Business School collaborated on research in the evaluation of the many approaches in determining constituent weights of equity indices.
The first empirical investigation examined a number of index construction techniques that comprised two categories:
1. Heuristic - simple techniques based on a rule of thumb
2. Optimised - techniques involving more complex optimisation procedures
The main finding of this research was that over the period from 1968 to 2011, all the alternative indices considered produced a better risk-adjusted performance than would have been achieved by passive exposure to a market capitalisation-weighted index. Indeed, it was determined that even a random choice of constituent weights would often have produced a superior performance, especially in comparison to the relatively poor investment returns offered by the market capitalisation approach. The full research paper "An evaluation of alternative equity indices. Part 1: Heuristic and optimised weighting schemes (latest version)" can be downloaded at the link below.
In the second investigation, a further approach for determining constituent weights for equity indices was explored. This particular approach is referred to as Fundamental Indexation. The research explored the performance characteristics of indices of US equities weighted according to:
- total dividends paid by a company;
- each company's total annual cashflow;
- each company's book value;
- each company's total annual sales
and also according to a combination of these.
The results showed that between 1968 and 2011 these fundamental index alternatives out-performed a comparable market capitalisation index. The full research paper "An evaluation of alternative equity indices. Part 2: Fundamental weighting schemes (latest version)" can be downloaded at the second link below.
Dr Nick Motson discusses this research in our video 'Monkeys' beat market cap indices.
This research was developed with the guidance of our Cass Consulting service.