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Market Cap Weighted Index

  • 11-10-2018 10:20am
    #1
    RedRochey
    Registered Users, Registered Users 2 Posts: 1,298 ✭✭✭


    One of the disadvantages of a market cap weighted index fund is that as a share price rises, the index fund has to buy more of it, the opposite being true as well, as a share price falls, the index fund has to sell it.

    I don't quiet understand this because if the share price increases, then the weighting in the fund will increase as well, so when will the index fund have to buy more shares?

    Example: Company A has 1,000,000 shares at a price of €45, giving it a market cap of €45million. Say the market has a market cap of €232.5, Company A's weighting would be 19.4%. So an index fund would hold 19.4% of the fund in Company A.

    Now say the price rises 10% to €49.5, the weighting in the market is now 20.9%, but the weighting in the fund also increases to 20.9%. So in what scenario does the index fund end up having to buy more shares?

    Or am I missing something fundamental to index funds?


Comments

  • #2
    The J Stands for Jay
    Registered Users, Registered Users 2 Posts: 5,876 ✭✭✭The J Stands for Jay


    StockTwat29 wrote: »
    One of the disadvantages of a market cap weighted index fund is that as a share price rises, the index fund has to buy more of it, the opposite being true as well, as a share price falls, the index fund has to sell it.

    I don't quiet understand this because if the share price increases, then the weighting in the fund will increase as well, so when will the index fund have to buy more shares?

    Example: Company A has 1,000,000 shares at a price of €45, giving it a market cap of €45million. Say the market has a market cap of €232.5, Company A's weighting would be 19.4%. So an index fund would hold 19.4% of the fund in Company A.

    Now say the price rises 10% to €49.5, the weighting in the market is now 20.9%, but the weighting in the fund also increases to 20.9%. So in what scenario does the index fund end up having to buy more shares?

    Or am I missing something fundamental to index funds?

    The main reason for trading would be if a Share left the index and was replaced.


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