Arnold Kling  

A Simple but Revolutionary Investment Idea

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Jeremy Siegel writes,


Fundamental indexation means that each stock in a portfolio is weighted not by its market capitalization, but by some fundamental metric, such as aggregate sales or aggregate dividends. Like capitalization-weighted indexes, fundamental indexes involve no security analysis but must be rebalanced periodically by purchasing more shares of firms whose price has gone down more than a fundamental metric, such as sales, and selling shares in those firms whose price has risen more than the fundamental metric.

...According to my research, dividend-weighted indexes outperform capitalization-weighted indexes and are particularly valuable at withstanding bear markets. For example, the Russell 3000 Index lost almost 50% of its value between the bull market peak of March 2000 and the October 2002 low. Over this same period, a comparable total market dividend-weighted index was virtually unchanged. A dividend weighted index did have a bear market, but it only corrected by 20%. Moreover, the dividend-weighted index bear market didn't start until March 2002, and it lasted only six months (compared to 24 months for the cap-weighted index). The dividend-weighted index is now about 40% above its March 2000 close, whereas the S&P 500 and Russell 3000 are still not yet back to even. A similar performance occurred in other bear markets.

The historical data make an extremely persuasive case for fundamental indexing. From 1964 through 2005, a total market dividend-weighted index of all U.S. stocks outperformed a capitalization-weighted total market index by 123 basis points a year and did so with lower volatility.


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TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/527
The author at Bayesian Investor Blog in a related article titled How to Weight Holdings in Stock Funds writes:
    For those investors who (unlike me) can't afford to do fundamental analysis on a large number of companies (and if you can't afford to analyze thousands of companies, you're probably using a questionable method to select which ones to analyze), there's... [Tracked on June 17, 2006 12:33 PM]
COMMENTS (6 to date)
Ironman writes:

Nice to see some additional confirmation that fundamental indexing is a viable investing strategy.

Now, all we need is for the brokerage houses to create a new generation of ETFs and mutual funds that will allow investors to actually do it!

ErikR writes:

"Now, all we need is for the brokerage houses to create a new generation of ETFs and mutual funds that will allow investors to actually do it!"

Ticker: PRF

purpleslog writes:

"Recently, Roger Arnott has rocked the indexing world with
the introduction of the Research Associates RAFI 1000 index,
which is now tradeable in ETF form (ticker: PRF). In short,
Arnott contends that market value weighting in indexes is inefficient,
and that indexes should be weighted by fundamental factors such as price
to book, price to cash flow, and others. Arnott contends that his RAFI 1000
index has dramatically outperformed the S&P 500 for the last 40 years
(This is calculated via back testing, of course)."


I don't rememember were I clipped the above text from, sorry.

Ironman writes:

ErikR & purpleslog,

Thanks for identifying PRF - although I was already aware of its existence, I should have noted it in my original comment. My point, which I should have made more clear, is that there should be more such ETFs, offering investors the opportunity to select a particular fundamental performance measure for weighting the fund in which they choose to invest.

That way, we would have the option of choosing the dividend-weighted index investigated by Siegel, instead of just Arnott's PRF ETF - although, you have to admit, for the six-month period encompassing its short history, this fund of 1000 stocks has already outperformed the S&P 500 and the Nasdaq!

The Dow is a different story, but one that might be expected given that it only consists of 30 stocks that also benefit from the "flight to quality" during bearish markets.

Ironman writes:

I've answered the question - the quick summary: they're on the way, pending SEC approval.

Tom writes:

I've long thought that an Earnings Weighted index would be a very good investment approach.

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