Fundamental Indexation

A trillion-dollar industry is based on investing in or benchmarking to capitalization-weighted indexes, even though the finance literature rejects the mean–variance efficiency of such indexes. This study investigates whether stock market indexes based on an array of cap-indifferent measures of company size are more mean–variance efficient than those based on market cap. These “Fundamental” indexes were found to deliver consistent, significant benefits relative to standard cap-weighted indexes. The true importance of the difference may have been best noted by Benjamin Graham: In the short run, the market is a voting machine, but in the long run, it is a weighing machine. he capital asset pricing model (CAPM) says that the “market portfolio ” is mean– variance optimal. Although the model is predicated on an array of assumptions, most of which are arguably not accurate, it leads to the conclusion that a passive investor/manager can do no better than holding a market portfolio. The finance industry, with considerable inspira-