Fundamental Indexing: New Ain't Necessarily Bad

Roger Nusbaum submits: MarketWatch interviewed Gus Sauter from Vanguard about ETFs, including a little bit about fundamental indexing.

Of fundamental indexing Sauter says among other things:

Why does anyone think it's simple to come up with a formula that's going to be able to add a return above the market when active managers haven't been able to?

While he has a point, WisdomTree has backtested their domestic funds back to 1964 and, well, the results are better than cap weighting. There are plenty of caveats to be sure, but 40 years may not be a fluke.

It seems to me that people in the market-cap weighting business could be in a bit of a pickle. First, what are they supposed to say about fundamental indexing? "Um, yeah, we think our way is inferior."

For the individual investor none of this matters. You have the luxury of having all sorts of methodologies in your account without having to be loyal to any of them. I would imagine that for some things, market-cap weighting is better, but for others you should probably use a fundamentally weighted product, if you use these things at all.

It is not intuitive to me that investing methods can't evolve, which is my take on what the market-cap crowd is saying. I recently posited that the newer commodity ETFs might be a better way to go than the older ETFs (just a theory with no conclusion). In the last 35 years or so we have seen the options market, the Nasdaq and I believe most of the futures markets all created. So the idea that things always stay the same is upside down.

Comments

[Amit Chokshi_:]

Fundamental indexing is a great alternative to traditional indexing, I doubt the market cap indexers have really looked at how it can work. Only issue I have is that WisdomTree gets a lot of credit for it when I believe Rob Arnott is the guy that really laid the groundwork for it. Fundamental indexing is not just a "value strategy" like some say, you can index across number of employees, revenues, cash flow, book equity, not just the highest paying dividends, etc. John Mauldin's book Bullseye Investing has a great chapter about fundamental indexing based on Arnott's research and that book was written I think 4+ years ago.

2007 Jan 30 03:06 PM

[Tony Festa:]

I agree with Amit, in that, I too believe that Rob Arnott is the original pioneer for Fundamental Indexing. And, in my opinion, likely offers the most realistic alternative to determing company size. I'm currently researching Wisdom tree, and it's hard to get past the preconceived notion that Wisdom Tree is going to make a fortune by repackaging Value Investing. With their strategy being based on dividend yield (a common characteristic to value investing), it's not a surprise that they their 40+ year track record looks attractive, given value outperforms growth over long periods of time.

There is a growing evidence, however, that fundamental indexing provides a more efficient means for capturing the value premium, which would make sense given a more systematic approach applied to stock selection criteria. If investors can increase their alpha/ level of volatility, than that's where I could see Fundamental Indexing strategies really serving a niche in portfolios.

2007 Jan 30 03:49 PM

[ej76az:]

Where did you get the 40-year backtesting? WisdomTree's website only shows 10-year backtesting.

2007 Apr 09 05:32 PM

[Roger Nusbaum:]

it is possible that it is only available when you register as an adviser?

I would suggest calling them and asking, remember the 40 years is for the domestic dividend funds.

2007 Apr 09 06:04 PM

[ej76az:]

I e-mailed WT, and here's the absurd response I received:


Hello,

At this time WisdomTree has decided to only include backtesting data for 10 years to the public. While this is an abbreviated period from the 50 year backtest, we believe that it is a broad representation of the market cycles.

Thank you for your interest in WisdomTree. If you have any further questions feel free to email or call 1-866-909-9473 and we’ll be more than happy to answer them.

Sincerely,

Ryan Davis


A helluva way to run a railroad. WT sure won't be getting any of my money!

2007 Apr 10 12:58 PM