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Article

Myths about fundamental indexing

Published in: Investment Analysts Journal
Volume 47, issue 4, 2018 , pages: 304–326
DOI: 10.1080/10293523.2018.1483050
Author(s): Lieven De MoorVrije Universiteit Brussel, Faculty of Economic and Social Sciences and Solvay Business School, Belgium, Fang LiuBeijing Foreign Studies University, China, Piet SercuKU Leuven, Faculty of Economics and Business, Belgium

Abstract

Fundamental indexing starts from the observation that in a value-weighted portfolio, any overpricing affects the stock’s portfolio weight upward and its typical return downward, and vice versa; but on average the ‘drag’ on the portfolio’s expected return caused by this negative interaction is avoided if weights are based instead on accounting-based instruments for true value. We find that the drag effect is statistically and economically unimportant. Our empirical work avoids regression-based alphas, which are flawed by demonstrable instabilities in the exposures.

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