An article in CityWire suggests that investors should “forget the switch from active to passive” and consider investing in revenue-weighted indices.
Citing Schroders research, the article reports that over the past five years, about 60% of funds flowing into US equity ETFs has gone to alternative equity index strategies rather than those based on market capitalization, but the returns have been largely disappointing. Instead, it suggests that revenue-weighted ETFs might be a better choice. “Revenue weighting as plenty of advantages,” it argues, adding, “It is intuitive, it naturally favors larger corporations—which should be more liquid—and unlike profits, revenues are overwhelmingly positive, more stable from quarter to quarter and harder to manipulate.”
The article cites research conducted by a team at Harvard Business School showing that between 1995 and 2017, revenue weighting beat market cap-weighted indices “100% of the time over 10- and 15-year periods for small, mid and large caps.” It also notes that when these returns are broken down into factors, revenue-based indices “amplified exposure to size and value and reduced the momentum bias relative to the S&P 500. A key component of this is that revenue indices have tended to diversify across sectors, most notably minimizing bubbles that inflate market caps.”
The Harvard team concluded that revenue weighting “appears to be a strong contender for at least a portion of the assets that one wishes to allocate to broad indexation.”