We think it is important to be mindful of how an annual rebalance back to an underlying fundamental such as dividends can help manage valuation risks. With market capitalization-weighted indexes, when constituents increase in price compared to other stocks, they gain greater weight and increase their impact on the performance of the index. WisdomTree Indexes employ a rules-based rebalancing mechanism that adjusts relative weights based on underlying dividend trends. This is all the more important as Japan transitions from a momentum-led market in 2013 toward a more traditional value opportunity that we believe Japan represents today.
Explaining the Rebalance Process
During the rebalancing process, which occurs once per year for each Index, the relationship between price change and dividend growth is measured. Dividend Growth is a key factor in determining which companies get increased weight at each rebalance. This is a crucial differentiating factor of WisdomTree’s indexing approach.
Below we outline how the annual screening data impacted the WisdomTree Japan Hedged Equity Index. We will compare its sector composition before the rebalance to its sector composition after. Additionally, we compare its underlying sector performance to the broad Index to look at the average performance of sectors that saw their weights increase or decrease.
It is the interaction of dividend growth and price performance that provides the basis for determining which sectors tend to see increases or decreases in weight at the annual WisdomTree Index rebalance. Sectors that exhibit particularly strong performance must grow their dividends commensurately to maintain their weights. Sectors exhibiting weaker performance (assuming, of course, they’re not reducing their dividends commensurately) could be more likely to have their weights increased.
WisdomTree Japan Hedged Equity Index (WTIDJH) Sector Changes