RT Journal Article
SR Electronic
T1 The Arithmetic of Fundamental Indexing
JF The Journal of Investing
FD Institutional Investor Journals
SP 114
OP 118
DO 10.3905/joi.2008.707223
VO 17
IS 2
A1 Dopfel, Frederick E.
YR 2008
UL http://joi.pm-research.com/content/17/2/114.abstract
AB Fundamental indexing is a strategy for investing that deliberately ignores security market prices and instead weights securities proportional to fundamental measures of size such as cash flow, sales, book value and dividends. Such examples of “market value indifferent” portfolios may be referred to as indexes, but they actually generate active exposures intended to outperform capitalization-weighted benchmarks. Thus, these strategies are subject to the same “zero-sum game” arithmetic as other active strategies and may either outperform or underperform the benchmark over any period. The article proposes criteria that should be applied before investing in fundamental and other rule-based active strategies. Otherwise, if the conditions are not satisfied, the investor is better off with cap-weighted indexing that efficiently replicates the performance of the average investor with minimal trading costs and without any presumption of above-average skill.