Robert Arnott's magic indexing formula

/.../

Arnott's Big Idea is a concept he calls "fundamental indexing." It's a system that allocates money to stocks based on the economic footprint of the underlying companies rather than by the more common method of market capitalization. As we'll see, it's a near-revolutionary challenge to the accepted wisdom about passive investing. And it has already won over a range of large institutional clients, from the national pension fund of France to CalPERS, the $200 billion retirement fund for California's public employees. "Rob is one of a handful of guys on the cutting edge of investment thinking," says Dan Bienvenue, a senior portfolio manager at CalPERS. "In conventional indexing you're always average. Rob's method has historically beaten the average."

/.../

Why do fundamental indexes fare far better? The principal reason is that they are regularly rebalancing their holdings by selling expensive stocks and buying cheap ones, relentlessly exploiting what's known as the "value effect." It's well established, both in academic studies and through decades of fund performance, that "value stocks," companies with low price/earnings multiples and low price/book ratios, perform better over time than expensive growth stocks that boast high P/Es. "The market does a good job choosing which companies will grow and which will shrink," says Arnott. "The problem is that investors pay too much for hot, glamorous growth stocks and set the bar too high." In the fundamental index, the rebalancing goes strictly by formula: When a company's market cap jumps faster than its sales or profits, the fund sells just enough of it so that its investment once again reflects not its price but its scale in the economy.

/.../

After the big rally over the past year, stocks would appear to be extremely expensive. But Jason Hsu, one of Arnott's chief lieutenants, says that while tech and health care are carrying prices far in excess of their economic size, a lot of big companies still appear cheap, including financials, industrials, and large retailers. The cap-weighted funds, however, are putting half their money in just one-quarter of the stocks, an unusually large bet on expensive companies. In other words, the market is paying dearly for growth that may not happen. Arnott is confident how things will turn out. "When the gap between the cheap and the expensive is this big," he says, "the fundamental index usually outperforms by more than the traditional two points."

nekaj za indexerje :)