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New Paradigms in Stock Market Indexing

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  • Derek Jun
  • Burton G. Malkiel

Abstract

"Considerable recent interest has been shown in a new set of stock-market indices that are weighted by fundamental factors such as sales, earnings, dividends or book values, rather than by capitalization. In this paper, we analyze the performance of Fundamental Indexing™ ("FI"). First, we show that the source of FI's recent excellent performance is not from its ability to systematically arbitrage mispricing in a noisy market but from increasing the portfolio's exposure to stocks with low price-to-book values and with small capitalizations. We find that FI does not produce a positive alpha when its excess returns are explained by the Fama-French three-factor model of CAPM beta, the value premium and the size premium. Second, we show that it is possible to construct a portfolio of exchange-traded funds with similar factor loadings that can replicate, and sometimes, even outperform FI. However, we caution investors not to expect consistent outperformance from portfolios tilted towards value and small-cap stocks. Historical data shows evidence of mean reversion in the performance of such strategies." Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

Suggested Citation

  • Derek Jun & Burton G. Malkiel, 2008. "New Paradigms in Stock Market Indexing," European Financial Management, European Financial Management Association, vol. 14(1), pages 118-126.
  • Handle: RePEc:bla:eufman:v:14:y:2008:i:1:p:118-126
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-036X.2007.00432.x
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    Cited by:

    1. Walkshäusl, Christian & Lobe, Sebastian, 2010. "Fundamental indexing around the world," Review of Financial Economics, Elsevier, vol. 19(3), pages 117-127, August.
    2. repec:eee:finana:v:51:y:2017:i:c:p:1-15 is not listed on IDEAS
    3. Burton G. Malkiel & Derek Jun, 2009. "The Value Effect and the Market For Chinese Stocks," Working Papers 1177, Princeton University, Department of Economics, Center for Economic Policy Studies..
    4. Malkiel, Burton & Jun, Derek, 2009. "The "value" effect and the market for Chinese stocks," Emerging Markets Review, Elsevier, vol. 10(4), pages 227-241, December.
    5. Brigette Forbes & Anup Basu, 2011. "Does Fundamental Indexation Lead to Better Risk Adjusted Returns? New Evidence from Australian Securities Exchange," School of Economics and Finance Discussion Papers and Working Papers Series 275, School of Economics and Finance, Queensland University of Technology.
    6. repec:pri:cepsud:188malkiel is not listed on IDEAS

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