Fundamental Indexing

Enhanced Indexing

Enhanced indexing attempts to generate modest excess returns compared to index funds and other passive management techniques by combining elements of passive management and active management.  Enhanced indexing strategies generally have low turnover and lower fees than actively managed portfolios.

However, enhanced indexing also to a certain extent resembles active management because it allows managers the latitude to certain deviations from underlying index. These deviations can be used to improve portfolio performance, minimise transaction costs and turnover, or to maximise tax efficiency.

Fundamentally based indexes are indices in which stocks are weighted by one of many economic fundamental factors.  A key belief behind the fundamental index methodology is that underlying corporate accounting/valuation figures are more accurate estimators of a company's intrinsic value than the listed market value of the company.  In this sense fundamental indexing is linked to fundamental analysis.

The fundamental factors commonly used by fundamental index managers are sales, earnings, book value, cash flow and dividends. Fundamental indices take advantage of value stock discounts which have been present in international stock markets during the last 30–40 years so it is not strange that they have been repeatedly shown to beat the market. 

There is academic evidence, with statistical significance, that fundamental indices create more value than capitalisation weighted indices and since they are fundamentally based, fundamental indexes can reduce investors chances in participating in bubbles and crashes and reduces volatility while delivering a higher return.

Forty years of back-tested Indices weighted by any of several fundamental factors including sales and earnings, in U.S. markets outperformed the S&P 500 by approximately 2% per annum with volatility similar to the S&P 500.  In non-U.S. markets, fundamentally based indices outperformed capitalisation weighted indices by approximately 2.5% with slightly less volatility and outperformed in all 23 MSCI EAFE countries.

Does your investment manager use a strategy based on sound academic theory and empirical evidence of outperformance?  Or instead are they throwing darts?

Does your portfolio manager outperform the market, after taxes and fees?

Scout Investments offer comprehensive investment, insurance, and mortgage solutions at the lowest cost to our clients. 

kevin@scoutinvestment.ca        

                  

www.scoutinvestments.ca                                      

1-800-795-6701