An Anatomy of Fundamental Indexing
Adherents of Fundamental Indexing (FI) suggest that it is more pro table to base portfolio weights on indirectly size-related indicators like accounting data rather than directly on market caps. In noisy markets a la Roll (1984), it is argued, underpriced stocks overperform but are underweighted and vice versa, implying a `drag' which FI claims to avoid. Mixed into the debate is the question whether mispricing is partly identi able or not, i.e. whether a policy of actively increasing the small-cap weights and vv helps. Carhart style regressions are unable to explain the extra return, but that conclusion is not robust across variant models, and there are substantial doubts about the constantness of factor sensitivities. We investigate the latter issue via cross-sectional regression of weight shifts, and find that not only the weight shifts are much larger than necessary to avoid drag, but the cross-sectional patterns are also quite variable over time. In short, there are style shifts and they are unstable. To estimate the benefits from drag avoidance, purged of style shifts without having to rely on generalized FF regressions, our procedure is to sort stocks on size into vigintiles, and compare within each vigintile the performance of FI-weighted returns to equally-weighted (EW) returns, which should be immune to drag too without much style shift. We find that within-vigintile EW portfolios are style neutral w.r.t. market and value, and do not meaningfully outperform VW portfolios. Thus, avoiding drag is not why FI does well: drag is empirically unimportant. Most or all of the prima facie bene ts must be from time-varying style shifts
|Date of creation:||Mar 2012|
|Contact details of provider:|| Web page: http://research.hubrussel.be|
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:hub:wpecon:201215. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sabine Janssens)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.