Myths about fundamental indexing

Fundamental indexing starts from the observation that in a value- weighted portfolio, any overpricing affects the stock’s portfolio weight upward and its typical return downward, and vice versa; but on average the ‘drag’ on the portfolio’s expected return caused by this negative interaction is avoided if weights are based instead on accounting-based instruments for true value. We find that the drag effect is statistically and economically unimportant. Our empirical work avoids regression- based alphas, which are flawed by demonstrable instabilities in the exposures.status: Published onlin