When to Use Market Cap Weighted ETFs

Investors that go against the natural market-cap-weighting process begin to stack the deck against themselves - but is the traditional approach always best?

Morningstar ETF Analysts 31 May, 2017 | 4:18PM

Deviating from a cap-weighted strategy leads to higher costs

The stock market is simply the sum of all transactions for shares of publicly listed companies, millions of which are conducted every day. Hour by hour, minute by minute, Benjamin Graham's voting machine is hard at work as market participants express their opinions regarding a company's future prospects through the price at which its shares transact. In a rational world, these opinions and the ensuing actions are based on an investor's knowledge and understanding of these firms. New information is combined with old, and prices fluctuate through a continuous auction-like process.

A company's share price that results from this system, when multiplied by total shares outstanding, forms its market capitalisation. Thus, as a company's share price appreciates, its market capitalisation and enterprise value grows, increasing in value relative to the overall market. With size comes benefits, including economies of scale, diversified revenue streams, and brand recognition. The winners of the competitive election process grow bigger and prosper, while the losers are relegated to the boneyard of capitalism.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Morningstar ETF Analysts  research hundreds of ETFs available to European investors. The Morningstar Rating for ETFs is based on a risk-adjusted performance measure

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