Origins of the Fundamental Index Concept

A better-than-expected industrial production number from the US and a hostile takeover bid for Potash got North American stock indexes off to a good start this morning. On the bearish side of the economic fence however was a lower than expected US housing start number for the month of July, and according to the Federal Reserve's loan officer survey: demand for loans at the majority of US lenders in the US failed to rise even as banks eased their lending standards. Loan demand has become somewhat price inelastic and highlights the challenges faced by central bankers to preserve the economic recovery.

Now continuing my summary of The Fundamental Index, the reasons behind the growing popularity behind passive index investing in general are: market performance at next to nothing in fees, trading costs, or other expenses; and the fact that most active manager deliver less performance than the market, but for higher fees. The problem however with cap-weighted indexes is the market routinely miss-prices stocks, resulting in too much exposure to larger cap stocks which tend to under-perform, and too little exposure to smaller cap stocks which tend to outperform. According to work done by Research Affiliates, just by excluding the top 10 market cap stocks on the S&P 500 resulted in better performance over any one, three, five, and ten year period going back to 1926.

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