CIP Unbiased Index

The Theory

Every published market index is simply a compilation of a basket of securities that purportedly represents the market as a whole, or some segment of the market. The selection and the weighting scheme used to build the basket of securities influences how the “index” will perform. The S&P 500 is 500 securities selected by a committee and market cap weighted. The Russell 1000 is 1000 securities selected and weighted based on a combination of market cap and float. Over time the two indexes are highly correlated. Over the short run, however, material differences in performance are observed. Both indexes purport to represent the domestic large cap market. Other methods exist including the 30 stocks in the Dow Jones Industrial Average, and equal weighting as examples.

Efficient market proponents bristle at the notion of enhanced methods of indexing, claiming that passive selection based on market capitalization is the best measure of the “size” of the company and therefore its representation in the broader economy. We find that bias’ develop in using market cap because of the influence of market expectations caught up in the price-to-earnings ratio. Recall that the market cap of a company is equivalent to: (Earnings * Shares Outstanding * Price to Earnings Ratio). The argument is that this method systematically results in investors allocating more money to stocks with higher P/E ratios and less money to stocks with lower P/E ratios.

Our position is that arguing which method is more theoretically “pure” misses the fact that other methods of constructing a broad basket of securities that “represent” the investable base of corporate America outperforms its market cap alternative over medium to longer investment cycles at a commensurate level of risk and turnover.

CIP Unbiased Index Strategy

Our research focused in two areas: First, the source of the alpha. Without understanding why alpha is produced, confidence that the performance would be repeated in the future would be low. Second, our research team set out to test various factors in an effort to identify those that avoided or mitigated the influence of other biases that may creep into the process.

CIP research has identified a number of sources of alpha that are systemic to the process and repeatable. The CIP Unbiased Strategy uses a series of factors based on extensive research into the risk and return characteristics introduced. The end result is a strategy which we believe captures the alpha potential in the universe of large cap equity securities.

Fact Sheet