WisdomTree has attempted to deal with that problem by having what’s known as a fundamentally weighted index. The rule is to weight companies in relation to their net income. However, this approach doesn’t really solve the top-heaviness problem. For example, if WisdomTree were to create its version of the Spanish ETF, Telefonica would still have a very large weight in the index, because the company is so much more profitable than the average company in Spain.
In his so-called RAFI indices, Robert Arnott has taken a different and more complicated approach by creating a whole series of fundamental factors to alter the company weights, with a view of reducing the impact of any one company, or small group of companies, that might be temporarily overvalued. At the end of the day, however, the companies with the largest market capitalizations generally have the most weight in the index.
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