I<\/span>f you want a white T-shirt, someone is always prepared to sell you a \u2018better\u2019 white T-shirt. For you sir \/ madam, may I suggest a Loro Piana white jobbie<\/a>\u00a0for a mere \u00a31,795?<\/p>\n How superior can this seventh wonder of capitalism be? Is Loro Piana\u2019s T-shirt really 32,536% better than Next\u2019s Basic Crew Neck, currently yours for just \u00a35.50?<\/p>\n We grizzly frugalists may scoff \u2013 but we face a similar face-off whenever we\u2019re tempted by smooth marketing sirens who insinuate that a plain market cap-weighted index tracker<\/a> may not be all that\u2026as they slide a reassuringly expensive alternative across the table.<\/p>\n Market capitalisation-weighted indexes provide the motive power that drives the majority of index funds and ETFs<\/a>.<\/p>\n The S&P 500, MSCI, World and FTSE All-Share are all good examples of market cap indexes.<\/p>\n For \u2018market cap-weighted\u2019 read \u2018weights its holdings by market value\u2019.<\/p>\n Essentially, a market cap index ranks its constituents by the value of their tradable shares.<\/p>\n For example, the S&P 500 is an index composed of 500 leading US-listed companies.<\/p>\n The total market value of Apple\u2019s shares as a percentage of the S&P 500 is currently 7.2%. So a market cap-weighted S&P 500 ETF<\/a> allocates around 7.2% to Apple at the time of writing.<\/p>\n In contrast, Apple\u2019s percentage share would be just 0.2% in an S&P 500 ETF that weighted each holding equally.<\/p>\n As it is, one of the smallest holdings in the S&P 500 is the FMC Corporation. That \u2018if you know, you know\u2019 chemicals manufacturer is worth 0.01% of the entire index.<\/p>\n The point is that the market has decided Apple is about 71,900% more valuable than FMC Corp right now. And that\u2019s probably a better bet than any designer white T-shirt.<\/p>\n Accepting that the wisdom of the crowd is the informed choice is a bit like overcoming a Jedi trial en-route to investing enlightenment.<\/p>\n As real-life investing Yoda\u00a0Warren Buffett<\/a>\u00a0puts it:<\/p>\n By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals.<\/p>\n Paradoxically, when \u2018dumb\u2019 money acknowledges its limitations, it ceases to be dumb.<\/p>\n<\/blockquote>\n By \u201cindex fund\u201d<\/em>, Buffett is talking about any broadly diversified tracker driven by a standard-issue market cap-weighted index.<\/p>\n Ex-hedge fund manager Lars Kroijer<\/a> expands on the theme:<\/p>\n A [market cap weighted]<\/em> world index tracker enables you to let the global capital markets do the hard work of figuring out where your money will earn the best return \u2013 because that is what is reflected in the various regional weightings in a world tracker fund.<\/p>\n International capital has spoken. You can just enjoy the ride.<\/p>\n<\/blockquote>\n The problem is it\u2019s hard to believe there isn\u2019t something better out there.<\/p>\n After all, market cap index trackers are the plainest, bog standardest, cheapest products you can buy.<\/p>\n They are that Next \u00a35.50 Crew Neck T-Shirt.<\/p>\n They\u2019re Aldi\u2019s Everyday Essentials Baked Beans In Tomato Sauce. RRP: 60p per kg.<\/p>\n But surely Mr Organic\u2019s Made in Italy Organic Low Sugar Baked Beans<\/a>, Certified Non GMO & Preservative Free, Gluten Free & Vegan, Made With White Beans, Natural Herbs & Spices in a BPA-Free Tin (RRP: \u00a349.88 per kg) are much better for you?<\/p>\n Okay, maybe that is<\/em> insane, but Waitrose\u2019s Duchy Organic Baked Beans in Tomato Sauce sure have a nice label. And likely a royal seal of approval. And they\u2019re only \u00a32.39 a kg. Or 298% more expensive than Aldi\u2019s beans. Anyone for a blind taste test?<\/p>\n Alright, that\u2019s a lot of talk about baked beans. But the reason I keep water-boarding this metaphor is because, like beans and tees, market cap index trackers are commodity products.<\/p>\n That is, such trackers are largely indistinguishable from others of the same type. They primarily compete on price rather than features. Many suppliers offer nearly identical products, leading to intense competition. And buyers can easily switch brands without significant consequence:<\/p>\n Data from JustETF<\/a>. 28 February 2025.<\/p>\n This is a great situation for us, the buyers. We\u2019ve got oodles of cheap and well-made products to choose from.<\/p>\n But it\u2019s far from ideal for the embattled investment firms bidding for our money.<\/p>\n If everyone\u2019s happy with the market cap product then the suppliers can\u2019t differentiate.<\/p>\n Instead they\u2019re doomed to ever-eroding profit margins in the worst of all business worlds: eternal price war!<\/p>\n Cold logic dictates the financial services industry will instead try to upsell to us.<\/p>\n Hence, for a little extra, you can buy flashier trackers powered by:<\/p>\n The alternatively-weighted index trackers are beautifully packaged.<\/p>\n You get a story \u2013 sorry, thesis \u2013 which explains why they may<\/strong> outclass the standard market cap solution.<\/p>\n Or perhaps solve some flaw that may \u2013 or may not \u2013 be inherent to market cap index design.<\/p>\n In the best case, the narrative is rooted in independent research that details why the alternative weighting has succeeded in the past and could do so again. Though that still doesn\u2019t guarantee the resultant product is a good real-world solution.<\/p>\n A glossy back-test will also be included. This simulation always demonstrates the efficacy of the product \u2013 in an alternate historical universe where it actually existed.<\/p>\n But sadly many strategies that glitter in the data mine lose their lustre in the cold light of day.<\/p>\n Which brings us to the forward test\u2026<\/p>\n A wide range of alternatively-weighted developed market indices have been available for many years now. Time enough that we can field test their potency versus our market cap baked beans.<\/p>\n Below\u2019s a sweep of alternatively-weighted ETFs in the developed market equities category, benchmarked against an MSCI World market-cap driven ETF:<\/p>\n I\u2019ve chosen the longest possible comparison period for this ETF selection: 4 September 2015 \u2013 28 February 2025. Indices are based on the MSCI World stock universe where available.<\/p>\n The market cap product came third out of a field of 12.<\/p>\n Only Momentum and Quality did better over this period. The SRI-screened version of the MSCI World came close. The rest trailed by a considerable margin.<\/p>\n Quality beat the Market Cap ETF by less than 0.2% annualised. Neither here nor there.<\/p>\n Momentum won by almost 2% a year though. I\u2019d definitely take that!<\/p>\n But we\u2019re back to the old dilemma. Could you have predicted the winners of this race some ten years ago?<\/p>\n Indeed if you were investing at the time, did you predict it<\/strong>?<\/p>\n I didn\u2019t. I was invested in Quality and Momentum via a Multi-factor ETF. However, that product also invested in Value and Small Cap, and it lagged the market by 2% annualised overall.<\/p>\n There\u2019s no guarantee that Momentum will dominate the next ten years.<\/p>\n None at all.<\/p>\n There\u2019s another way of looking at investment performance: through the lens of risk-adjusted returns.<\/p>\n Risk-adjusted returns measure an investment\u2019s performance relative to the amount of risk taken to achieve it. A high return investment might seem very attractive versus a lower return option \u2013 until you consider their respective volatility.<\/p>\n To account for this, a metric like the Sharpe ratio<\/strong> helps you determine if an investment is delivering superior returns for the level of risk taken.<\/p>\n Rational investors are meant to prefer the investment with the best risk-adjusted returns. As opposed to just the investment with the highest return, irrespective of the psychological torture it may inflict along the way.<\/p>\n Happily, the website justETF<\/em> enables us to calculate the Sharpe ratio for each ETF by comparing annualised returns against volatility.<\/p>\n The higher the Sharpe ratio, the better the risk-adjusted returns. In other words, the more return you get per unit of risk, as measured by volatility.<\/p>\n justETF<\/em> presents the information as a pretty but hard-to-read heat map:<\/p>\nIf the market cap fits<\/h4>\n
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So what\u2019s the problem?<\/h2>\n
Spot the difference: MSCI World ETF 1-year returns \u2013 market cap weighted<\/h4>\n
![\"A](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2025\/03\/MSCI-World-1yr-returns.png?resize=1576%2C619&ssl=1\")
<\/a><\/p>\nTrading up?<\/h4>\n
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A taste of luxury<\/h3>\n
How did alternatively-weighted indices perform in the wild?<\/h3>\n
![\"A](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2025\/03\/Market-cap-vs-alternative-indices-copy.png?resize=1571%2C623&ssl=1\")
<\/a><\/p>\nRisk curious<\/h2>\n
![\"A](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2025\/03\/Market-cap-vs.risk-adjusted-annotated.png?resize=1576%2C626&ssl=1\")
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