There’s an ongoing debate about indexing when it comes to exchange traded funds (ETFs), and each side continually brings out new evidence and information to bolster their arguments.
Proponents of fundamental indexing contend that mutual funds and ETFs based on the S&P 500 are flawed in their designs, reports John Spence for The Wall Street Journal. The S&P 500 can be top-heavy with companies that have large market value, adding weight to the stocks.
- SPDR S&P 500 ETF (SPY): up 3.6% year-to-date
The new breed of funds that seek to remedy this issue are based on indexes that weight stocks by high dividend yields, low share-price-to-earnings ratios and various other factors. It is thought that these types of funds are less risky and provide better long-term performance.
- PowerShares FTSE RAFI US 1000 Portfolio (PRF): up 10.6% year-to-date
According to Rob Arnott, founder of Research Affiliates LLC and the father of fundamental indexing, the market does tend to incorrectly value stocks, and the solution should be to weight stocks by book value, cash flow, sales and dividends. Research Affiliates also readjusts its index annually by shifting its ETF into sectors with strong fundamentals but lower stock prices. The effect is to allow investors the benefit of capitalizing when the markets shift.
There are skeptics of this new methodology. Fundamental indexing could tend to lean toward “value” investing. But proponents claim fundamental-indexing strategies perform better environments like after market bubbles burst, not speculative markets.
Where do you stand? Talk about it in the forums!
For more information on indexing, visit our indexing category.
Max Chen contributed to this article.
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.