Fundamental Indexing: Marketing Hype or True Value Add?

Fundamental Indexing: Marketing Hype or True Value Add?
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Fundamental Indexing: Marketing Hype or True Value Add?

You may have have heard, or likely will soon hear about, a relatively newer investment approach that has gained popularity over the past 10 years called fundamental indexing. Fundamental index vehicles have plenty of aliases such as: strategic beta, smart beta or factor investing. At the core, fundamental indexing is about creating a better index (pool of securities) by excluding certain companies and including others based upon a defined financial filter. It is less about picking the best company and more about picking a pool of securities that has what is believed to be more desirable long-term financial characteristics. The growth of this segment has been impressive to say the least. Morningstar reported growth of the “Strategic Beta” category to $745 billion as of February 2017.

So, what is fundamental indexing? Fundamental indexing seeks to deliver better returns than traditional passive indexes by selecting different stocks or excluding stocks in a particular index, or using different weighting schemes based on different factors. These factors can be based on: dividends, low volatility, momentum, value and quality of a constituent company. Traditionally, many passive indexes are weighted by the size of the company in the index (owning more large companies and less small companies, for instance). Fundamental Indexing divides up the pool differently and can exclude some holdings in a cap weighted passive index.

As an investor, all you want to know is if these fundamental indexes actually add value to your portfolio or if it is just a fad or new sales pitch based upon incomplete or select evidence. The press and associated expansion of this fundamental indexing/smart beta/factor indexing approach has led to many fund companies rushing into the market to gather assets from investors seeking to enhance their portfolios with such holdings. When looking at a roster of fundamental indexing companies, I am interested in one thing; is the investment genuinely designed, with solid supporting evidence, to add value to an investor’s portfolio or is it simply a marketing scheme?

I focus on the mix of factors used and if solid, near irrefutable evidence exists that indicates the approach may result in ongoing (not just past historic) value to the portfolio. As a proponent of fundamental indexing, I do feel when used correctly in a portfolios, such hybrid vehicles can add value. This value might not be realized in shorter periods (the data shows the potential value add is less predictable in shorter periods of time), but statistically has and may continue to add decent incremental value over longer periods of time. In fact, very credible research from Nobel prize winning laureate Eugene Fama is supportive of the approach.

As you can see in the above graphic, over a longer time frame, some fundamental strategies have added significant upside value to a portfolio. The Investment team at Janiczek Wealth Management is continually monitoring new and longstanding approaches worthy of consideration. While we are cautionary because we believe a lot of marketing and sales hype goes on in the investment world, we also know great academic and professional vigor is behind some newer approaches that warrants our serious consideration. We strive to make sure our portfolios have proper market exposures utilizing what we consider to be, after vigorous vetting, the most predictably sound investment vehicles and strategies available. Fundamental Indexing is one such approach that meets this criteria.

Kyle Kersting

Kyle Kersting, CFA is Director of Investments at Janiczek® Wealth Management. Kyle’s experience includes expanding the firm’s Evidence Based Investing platform for high net worth investors ($2 to $20 million portfolios) and ultra-high net worth investors ($20 million+ portfolios). He graduated from Colorado State University with a Bachelor of Arts degree in Finance and Real Estate, and Regis University with a Master in Business Administration degree with a concentration in Finance.

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