The optimal partition of index funds from individual stocks

Use the  method on the optimal political aggregation of mini-states. his comment of mine from the Thoma blog might help:

Exchange rates, stock markets and other index style asset trades have restricted ability to partition the market because they maintain an aggregate measure. The investor is stuck with very many index funds with accurate info in each, or very few indices with little accuracy in each. We accept great imprecision when we rely on any combination of stocks and indices.
We need that math paper Thoma referenced on finding the best available partitions of a limited set viewed through an imprecise channel. With that paper we can minimize the heteroskedacity of index funds. Then we can hold some funds until the variances spreads, and the math paper tells us how to rearrange the indices.
In other words, the proper mix of value investing and index investing to gain the lowest transaction costs overall.