Fundamental Indexation and International Diversification

Abstract

As much as fundamental indexation is novel and controversial, international diversification is traditional and widely accepted. This article links both issues and evaluates a fundamental strategy of international diversification. Considering 16 country benchmarks that make up over 93% of the world market capitalization and a 32-year (1974-2005) sample period, the results here show that a dividend-weighted fundamental index outperforms a cap-weighted index by the substantial margin of 1.9% a year. However, if investors are willing to abandon cap-weighted portfolios, the results here also show that a simple value strategy that weights the same country benchmarks by dividend yields outperforms the dividend-weighted fundamental index by 1.7% year over the same period. All the strategies evaluated in this article can be easily implemented with widely-available, low-cost country index funds and ETFs.

Keywords: fundamental indexation, international diversification, portfolio management

JEL Classification: G11