Alternative indexing methods: point of reference – does it matter?

ABSTRACT Most equity investors use the market capitalization-weighted index as their main point of reference when assessing the relative risk characteristics of an investment. In the past, the choice of this index has been made automatically without questioning its impact on such an assessment. With the emergence of a new breed of indexing methods, other indexes are now available to investors to use as point of reference. This paper addresses the question of how sensitive a relative risk analysis is to changing the point of reference from a market capitalization-weighted index to an equal weighted index. Taking economic intuition and its "clean slate" index construction process into consideration, we conclude that it would make sense to use an equal-weighted index rather than a market capitalization-weighted index as a point of reference when conducting style and relative risk assessments of various indexing methods.