WisdomTree’s CIO argues that the days of market-capitalization-weighted indexing might very well be over.
The U.S. ETF market is maturing, coming off of the 20th anniversary since the inception of the very first U.S.-listed ETF—the SPDR S&P 500 (NYSEArca: SPY)—amid record asset levels, now hovering around the $1.4 trillion mark. It’s a milestone that has many looking for what the next chapter will be in a market that continues to captivate investor attention, but one that remains highly linked to market-capitalization strategies.
It may very well be that the days of market-cap dominance are over, Luciano Siracusano, chief investment officer at WisdomTree, recently told IndexUniverse’s Cinthia Murphy. As one of the heads behind WisdomTree’s proprietary fundamentally weighted indexes, and ETFs that track them, Siracusano argues that real-time performance would suggest that fundamentally weighted approaches don’t belong in the market’s fringes, but rather in the core of investors’ portfolios.
IU.com: There are a lot of people who look at fundamental indexing as one of the next big trends in the ETF market, but some say that fundamental indexing is really just another form of active management. How do you respond to that?
Siracusano: Well, often the people who are calling fundamentally weighted indexing a kind of active strategy are the defenders of cap-weighted indexing; they're defenders of the status quo. I think after five years of real-time data, people should just look at what's actually happened over the last five years. I remember when WisdomTree launched in 2006, there was a lot of media attention around fundamentally weighted indexing. I wrote an article in Index Universe in 2007 laying out the philosophical case for it. And at the time, people really had three or four criticisms.
One, they said, it's based on backtested data. It's based on stuff that worked over the last 40 years; no guarantee it'll work in the future. But now you've had five, six, seven years of real-time results, and what you've seen in equity markets all around the world—not just in the United States—the fundamentally weighted indexes have consistently outperformed the comparable capitalization-weighted index.
Secondly, many said fundamentally weighted indexing was nothing but a value strategy dressed up in something different. But it's not just a value index because we’re owning all of the securities in an equity market; we're not just selecting value stocks—we’re taking stocks that would qualify for value indexes, we’re taking the core part of the market, and we're taking growth stocks.
IU.com: So there’s no stock picking in what WisdomTree does?
Siracusano: In America, we'll take any company that's profitable and put it into our earnings-weighted index. In the dividend index, there are 1,300 stocks that pay dividends. We don't care if they pay a high dividend or a low dividend; if they pay a dividend, they go in our index.
And what we do is we reweight once a year based on income, earnings or dividends. And what's happened overwhelmingly is that the fundamentally weighted have beaten the cap weighted over the last five years in an environment where growth indexes beat value indexes in the United States.
IU.com: You have to ask the question, How did that happen?
Siracusano: Exactly. How could you have done that if all you have is a value strategy? How did you beat the market if growth beat value? Well, the conclusion is that there's something else going on here in addition to a core value tilt. And we believe it's just a flaw in cap weighted that we're taking advantage of, the fact that cap weighted never rebalances back to any measure of relative value. Fundamentally weighted indexes do that once a year.