Chartered Financial Analyst Level 2
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27 In a trending market, which of the following index characteristics most likely leads to higher returns?
Exam-Like
A
Using a floating weighting scheme rather than a fixed weighting
B
Rebalancing at an increased frequency rather than a lower frequency
C
Including a large weight of commodities that typically trade in contango rather than in backwardation
Explanation:
Explanation
In a trending market, the characteristic that most likely leads to higher returns is:
A: Using a floating weighting scheme rather than a fixed weighting
Why floating weighting works better in trending markets:
- Floating weighting (like momentum-based weighting) allows winners to continue rising
- It increases weights in commodities that are trending upward
- Decreases weights in commodities that are trending downward
- This captures and amplifies the trend effect
Why the other options are incorrect:
- B: Increased rebalancing frequency - This would actually hurt returns in trending markets by cutting off trends prematurely
- C: Large weight in contango commodities - Contango creates negative roll yields, which reduces returns, especially in trending markets
Floating weighting allows the index to dynamically adjust to market trends, making it the best choice for trending market conditions.
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