Rob Arnott, the godfather of fundamental indexing, licensed and filed a patent for the first exchange traded fund (ETF) based on a non-traditional weight.  Then WisdomTree came tn the scene and launched the biggest family of ETFs tracking indices based on fundamental criteria, such as dividends, rather than stock prices.

Lawrence Carrel for explains typical indices weight companies according to their stock market valuation, or market capitalization. This value is calculated by multiplying the total number of outstanding shares by the stock’s price. The criteria give a bigger weighting to large companies and higher-priced stocks over smaller companies and lower-priced stocks. Major benchmarks, such as the S&P, use this for their basis.

On the other hand, there is fundamental indexing which could potentially capture better market returns with lower volatility. The market-cap weighted indices are over-weighted with over priced stocks, while fundamental indexing’s theory is at any one time, a stocks price represents the best, unbiased estimate of its true value.

Although Arnott doesn’t have his patent, his work with fundamental indexing has certainly spread through the investment community.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.