The most popular index funds such the S&P500 Index fund and Nasdaq 100 Index fund are market cap weighted. This increases the weighting of stocks as they increase in value and decreases their weighting as their price drops. Instead of rebalancing towards cheaper stocks, this would seem to do the opposite.
Robert Arnott has published and patented the idea of a fundamental index that weights stocks based on efficiency weighting. He believes this type of index will outperform a cap-weighted index by several hundred basis points.
The Fundamental Index: A Better Way To Invest
https://www.amazon.com/dp/047027784X/
In the eyes of a value investor, a cap-weighted index fund over weights the overvalued stocks and under weights the undervalued stocks. This flies in the face of the efficient market hypothesis that all stocks are fairly valued. It’s an intriguing idea with many interesting implications.
