Modified Market-Cap Weighting
Capture an emerging theme while capping single-company risk
- Difficulty
- Moderate
- Time to result
- ~weeks to results
- Steps
- 5
- Confidence
- 97%
Modified market-cap weighting starts with conventional market-cap weights, so larger companies receive larger allocations, but adds ceilings that prevent one dominant constituent from overwhelming the theme. This is particularly useful in young industries because investors may have confidence in the structural trend without knowing which individual firms will ultimately win. Broad ownership captures the theme, while position caps reduce idiosyncratic risk. When a company exceeds its permitted maximum, the excess allocation is redistributed across other eligible holdings. The result sits between pure market-cap weighting, which can become highly concentrated, and equal weighting, which may give fragile small companies disproportionate influence. Periodic rebalancing restores the intended relationship between company size, thematic exposure, and concentration control.
Origin
Luis Berruga described Global X’s preferred thematic portfolio-weighting approach on Masters in Business.
Core principles
- 01Own the theme broadly when future winners remain uncertain
- 02Give larger established companies proportionally greater weight
- 03Cap individual holdings before one company dominates the portfolio
- 04Balance thematic exposure with idiosyncratic-risk control
How to run it
- 1
Build the eligible universe
Identify companies that satisfy the theme’s relevance, liquidity, and size requirements. Exclude businesses whose connection to the theme is incidental.
Pro tip Set eligibility rules before examining the resulting weights.
Watch out Loose eligibility criteria can dilute the portfolio’s intended exposure.
- 2
Calculate market-cap weights
Assign initial weights according to each eligible company’s market capitalization. This gives more established firms greater influence while retaining broad exposure.
Pro tip Use a consistent measurement date across all constituents.
Watch out Pure market-cap weights can allow one exceptional company to dominate.
- 3
Apply holding caps
Limit every company to the maximum permitted portfolio weight. Choose caps appropriate to the breadth and concentration of the underlying industry.
Pro tip Stress-test several caps to see how they affect diversification and tracking behavior.
Watch out Caps that are too high provide little protection, while very low caps effectively create an equal-weight portfolio.
- 4
Redistribute excess weight
Spread weight removed from capped companies among the remaining eligible holdings according to the methodology. Repeat the process if redistribution pushes another company over its cap.
Pro tip Document redistribution rules so the index remains reproducible.
Watch out Ad hoc redistribution can introduce unintended active bets.
- 5
Rebalance and monitor
Recalculate weights on a defined schedule and monitor concentration between rebalances. Verify that the portfolio still represents the theme rather than one company’s fortunes.
Pro tip Review both company-level caps and aggregate exposure to related business groups.
Watch out Rapid price appreciation can recreate concentration before the next scheduled rebalance.
In the wild
A pure market-cap e-commerce index could allow Amazon to reach roughly 45% of the portfolio. A modified approach preserves Amazon as a major holding but caps its weight, then distributes the excess among other qualifying e-commerce companies.
→ Investors retain broad e-commerce exposure while reducing dependence on one company.
A robotics universe contains several established manufacturers and many smaller specialists. The portfolio begins with market-cap weights, caps the largest firms, and redistributes excess weight across the remaining qualified companies.
→ The portfolio reflects differences in company scale without becoming a single-stock proxy.
Common mistakes
Using uncapped market-cap weights
A dominant company can turn a thematic portfolio into an indirect single-stock position, undermining the intended diversification.
Setting arbitrary caps
Caps should reflect the universe’s breadth and risk characteristics. An unexplained number can create unintended tilts or weak risk control.
Neglecting thematic purity
Weighting cannot repair an eligibility universe filled with companies that have only marginal exposure to the theme.
Is it for you?
Best for
It is best for portfolios covering young industries where the eventual winners and losers remain uncertain.
Not ideal for
It is not ideal when an investor intentionally wants a concentrated conviction portfolio or equal exposure to every constituent.
From the transcript
“In most cases we follow what we call it modified market cap wearing approach, particularly around thematic investing.”
“These are younger industries where you still don't really know who the winners and losers will be right.”
“That's why we have the weight of each company anyway between eight percent to twelve percent as a way to mitigate that idiosyncratic risk.”
From the episode
Luis Berruga on ETF Investments
Luis Berruga