Reimagining Index Funds
30 Pages Posted: 31 Oct 2023
Date Written: October 3, 2023
Abstract
“Gold-standard” cap-weighted indices have a buy-high and sell-low dynamic that causes a structural long-term performance drag. Of course, relative to itself, no index can underperform, which is the reason it goes unnoticed. If we use a company’s fundamentals to choose stocks—and then cap-weights them – improves the risk-adjusted returns of gold-standard cap-weighted indices. This index, which we call Fundamental-selection Cap-weighted (FS-CW), has outperformed the most popular cap-weighted equity indices around the world over the last 30 years, while reducing risk, and with additional benefits of slightly lower turnover and transaction costs. Live results further support its merits. Building a better index fund that can earn a superior risk-adjusted return versus other cap-weighted indices is not only possible—it is a reality!
Keywords: Cap-weighting, Fundamental Selection, Tracking Error, Outperformance, Indexation
JEL Classification: G11, G12, G14, G23
Suggested Citation: Suggested Citation