Seeing through the Smoke Screen of Fundamental Indexers: What are the Issues with Alternative Equity Index Strategies?

Noël Amenc, Felix Goltz, Shuyang Ye: With an ever-growing number of alternative index construction methods on offer, investors should, in principle, be thankful for comparative analysis.

Author(s):

Noel Amenc

Professor of Finance, Edhec Business School and Director, EDHEC-Risk Institute.

Felix Goltz

Head of Applied Research, EDHEC-Risk Institute.

Shuyang Ye

Quantitative Equity Analyst, EDHEC-Risk Institute.

Such comparison has recently been provided in several articles written by promoters of fundamentally-based equity indices. In particular, Arnott (2011) and Chow et al. (2011) offer a back-test of several alternative weighting strategies and come to the conclusion that there are no differences in performance and risk factor exposures of alternative weighting schemes; but when it comes to implementation, fundamental weighting schemes are superior. While the conclusions of these articles may not come as a surprise, it is important to mention that the results reported in these articles are based on a flawed methodology which has the potential to lead to misleading conclusions on the relative merits and the properties of various indices. Moreover, beyond the methodological flaws in these articles, such performance comparisons fail to address the more important question of the conceptual underpinnings of various alternative equity indices. In the end, such articles only set up a smoke screen which hides the real issues behind the different alternative weighting schemes. This short article tries to see through the smoke screen by pointing out the methodological flaws in recently published comparisons of back-tested performance, and by underlining some more important conceptual considerations with alternative indices.

Type: Working paper
Date: le 26/06/2012
Research Cluster : Finance

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