The Perils of Capitalization Weighting: Teva and the Tel Aviv 35 Index

Yesterdays action on the Tel Aviv stock exchange demonstrates the perils involved in capitalization weighted indices. Even after expanding the index from 25 to 35 stocks Teva still carries a weighting of 5.58% in the index thus the 17.5% drop in Teva produced a large 1.5% drop in the index.The sharp decline of Teva over the last year has held back the TA 35 index despite the global rallies in stocks and the appreciation of the Israeli Shekel vs the dollar,

Teva One Year Chart

Tel Aviv 35 Index One Year

As a basis of comparison the highest weighting in the S+P 500 is Apple at 3.8%.

The perils of small indices can be seen in the popular technology index ETF XLK where Apple has a 15% weighting and Microsoft a 10% weighting, It is not hard to calculate what a large drop in one of these stocks would do to the value of the ETF