Can somebody explain this to me and give me an example of how it affects the index.
Consider asset-weighted hedge fund index. As a hedge fund becomes “popular”, its assets under management increase and its weight in the index increases.
So it doesn’t have to do with the underlying returns of the fund (in other words the asset flows them selves are distorting that particular funds results), just the fact that it now takes up a larger percentage of the index and will skew the end result to that style?
Typically assets flow to the funds that perform well. As a result their weight in asset-weighted indices increases.
Makes sense. But high, sell low right! Thanks maratikus.