Fundamental indexation comes under renewed attack
| May 7th, 2007 | Filed under: CAPM / Alpha Theory | By: Alpha Male |
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Rob Arnott isn’t afraid to go against the grain. His “fundamental indexing” methodology ignores price and value-weighted indices and instead uses fundamental business metrics such as sales and revenue to construct investment benchmarks. He says this avoids the propensity for indices to overweight temporarily overvalued stocks and underweight temporarily undervalued stocks.
But the idea has always had its skeptics – many of whom argue that fundamental indexing amounts to value investing in disguise. After all, they say, it simply amounts to overweighting high book-to-price stocks and underweighting low book-to-price stocks. Arnott is well aware of such criticisms and apparently plans to launch a counter-offensive soon. According to P&I, that counter-offensive will involve none other than Harry Max Markowitz, father of modern portfolio theory.
P&I reports on a paper in the works by Harvard professor Andre Perold called “Fundamentally Flawed Indexing”. Apparently, those who have seen it say it makes a lot of sense. Eric Sorensen, president and CEO of PanAgora (see posting: “King of Quants“) tells P&I that fundamental indexation assumes “large-cap stocks are overvalued, and you don’t know that”.
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