August 06, 2018

The interaction between stocks returns and the weight of the stocks in an index or benchmark is a topic seldomly discussed by portfolio managers and or investment consultants. The correlation between the weights and returns of individual stocks as well as the variance in weight and returns on the index significantly affects the number of stocks outperforming and underperforming an index. Understanding the conditions under which the number of stocks outperforming the index may allow an active manager to identify cycles when they will have the wind at their back thereby creating an environment favorable to active managers. Similarly identifying the conditions under which the number of stocks underperform an index helps the managers identify the conditions when they will be swimming upstream which creates an environment somewhat hostile to active managers.

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