The Fundamental Index - Chapter 3: Investors' Greatest Errors

North American stock indexes are flat today, bouncing on both sides of red and green. There really is no news, but watch for Canadian bank earnings reports this week and next, starting with Bank of Montreal tomorrow.

The reference to alpha is everywhere, and the assumption is that all efforts to generate alpha will be rewarded. The quest for alpha is a zero-sum game less costs, which means that most alpha, net of those costs, is negative. While the crowd is searching for positive alpha, most won't find it; however, identifying and eliminating negative alpha is every bit as profitable as identifying positive alpha. In case you're wondering what alpha is, it's the excess in return or shortfall in return relative to some benchmark, or in this case an index.

Eliminating negative alpha is not only profitable, it is also easier than competing with the crowd for positive alpha. Four major sources of negative alpha are: 1. over-reliance on equity returns; 2. ignoring re-balancing opportunities; 3. chasing winners; and 4. cap weighting portfolios. Cap weighted index investing suffers from these same sources of negative alpha, but at a lower cost. Fundamental index investing eliminates these sources of negative alpha.

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