[perl4ever]

I don't think it's a good idea to guess what's over/undervalued. But equal weighting different industries is not quite the same thing. No matter how you weight things (by capitalization, by company, by industry, whatever) you are making assumptions about correlations. No dogma can tell you which is right a priori, because correlations change, especially in crises when it matters most.

Also...the total market, cap weighted, may be the optimal way to invest the whole world's capital - but that doesn't mean that it's the optimal way to invest, say, $50K. If you have $100B, say, you can't put it in a stock that's currently valued at $1B. But if you have $1000, you don't have that constraint.

Regardless of how the optimal portfolio may differ, when you're investing a relatively minute amount compared to the entire market, it's hard to imagine the optimum is not going to be different.

...You don't pilot your car under all the same constraints as an 18-wheeler, just because that's optimum for shipping large quantities.

[pedrocr]

>If you have $100B, say, you can't put it in a stock that's currently valued at $1B. But if you have $1000, you don't have that constraint.

Your argument is that there is a mispriced security somewhere that can be bought at a low price. There is currently only 1B$ of it available and so the professional manager with 100B$ to spend just doesn't bother to pick up that money. But you with just 1000$ can do it instead. What makes the professional manager pass up on that opportunity? He has at least as much money as you, why doesn't he invest at least that amount?

In reality that opportunity doesn't exist. Companies can't be consistently mispriced lower because there is too much demand for their stock. That's not how markets work for anything.

[perl4ever]

Every cap weighted fund has a cutoff where it omits companies that are too small. But even the stocks that are barely large enough to include don't contribute much to returns.

I don't think the small cap stock is "mispriced". Rather, it has a different value for different investors, and the market price is a compromise. That means different investors should probably have a different amount of it in a portfolio.

It's an abuse of theory to claim that since the market is efficient, you should ignore the things that make you different from the total market. For example, suppose you invest in tax-exempt investments when you are in a low tax bracket, or even when you are investing in a tax free account. Is that optimal because markets are efficient? Of course not. Because the value set by the market does not take into account the way in which you differ.

The reason to believe in index investing is because you understand your own lack of knowledge and are honest about it. That's a good thing, but it doesn't justify pretending you don't know things that you do know. People seem to have the same issue with probability, I find.

[avar]

I think you're arguing a point that isn't even being brought up in this thread or in the article.

Of course it's just fine to have an index fund that's weighted towards certain types of stock, e.g. there's the S&P 500, then various "woldwide" funds, EU-weighted funds etc. The risks & benefits of those are well understood. Nobody argues that different types of index funds shouldn't exist.

Similarly, there's funds that cater to specific regulations, e.g. investing heavily in "green" stocks which may be subsidized by the government, or avoiding certain taxes (e.g. lower turnover for lower capital gains).

Both of those are categorically different from supposing that you know better than other people that tech stock in 2017 is overvalued, and trying to move away from that in favor of something else. Now you're making an active investment move which history shows you're more likely to lose on as gain anything on.

[pedrocr]

>Every cap weighted fund has a cutoff where it omits companies that are too small.

The whole market isn't just S&P500 funds, if it was there wouldn't be much price discovery. But in the S&P500 I bet most cap weighted funds actually hold all the assets.

>I don't think the small cap stock is "mispriced".

For your argument to hold it has to be. Specifically it has to be priced lower than it should so that an equal weighted fund can outperform a cap weighted fund. If that was the case the large fund manager should pick up that opportunity anyway, even if he can only do it in a lesser percentage of his portfolio than the retail investor. When that then happens those opportunities disappear.

>That's a good thing, but it doesn't justify pretending you don't know things that you do know.

The problem is that you haven't named a single thing a retail investor knows that the 100B$ fund manager doesn't and can't take advantage of.