April 28, 2008 at 1:00 am by Tom Lydon
Fundamental indexes tracked by exchange traded funds (ETFs) are nothing new under the sun. Now the father of fundamental weighting is looking to do the same thing for bonds.
Robb Arnott, chairman of Research Affiliates, says cap-weighting magnifies the overvalued stocks’ affect on portfolios. Bonds ETFs are currently weighted similarly - by the amount issued - and Arnott wants to move away from that.
Arnott says fundamental indexing works best when there are a wide ranges between the fair value of a company and the stock or bond. Weighting according to this criteria cuts down on the heft of "fad" stocks, Jesse Emspak for Investor’s Business Daily says.
When applying the fundamental indexing principles to bonds, the risk that a bond can’t be paid back is taken into account. Among the data Arnott’s firm is looking at for weighting country bonds is population, gross domestic product, oil consumption and existing government debt. Taking all of this into account gives a truer picture of fair value.
The firm has not filed with the Securities and Exchange Commission (SEC) yet, and preliminary work is still being done.
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