The Fundamental Index: A Better Way to Beat the Market Book

Foreword     xiii
Preface     xvii
Efficient Indexing for an Inefficient Market     1
Evidence of Market Efficiency     2
The Case for Indexing     6
Evidence of Market Inefficiency     8
Conclusion     11
Origins of the Fundamental Index Concept     13
Origins of the Research Affiliates Fundamental Index (RAFI)     17
A Series of Aha! Moments     19
Research Affiliates Fundamental Index     22
Fundamental Index Performance     23
Concluding Thoughts: A Better Way to Invest     27
Investors' Greatest Errors     29
Negative Alpha     30
Practicing What We Preach     38
Conclusion     40
The Virtues of Index Funds     41
Appeal of Equity Investing     42
Equity Investing Choices     44
The One Guarantee in Investments-Cost Matters     47
Index Fund Advantages     49
Avoiding the Performance Game     55
Concluding Point     56
The Index Fund's Achilles' Heel     59
Market Efficiency: Two Interpretations     60
Constructing a Well-Functioning Index     63
The Achilles' Heel of Cap Weighting     66
The Problems with Equal Weighting     68
Concluding Thoughts     71
A Fundamental(ly) Better Index     73
Building the Fundamental Index     75
Adjustments for Non-Dividend-Paying Companies     76
Why Multiple Measures of Company Size?     80
Advantages of a Composite Measure     83
An Index of the Broad Economy     85
Capacity and Liquidity     88
Reconstituting the Fundamental Index: Keeping Turnover Low     91
Concluding Comments     95
Fundamental Index Performance in U.S. Stocks     97
RAFI U.S. Large Company Performance     98
Digging Deeper across Market Cycles     100
Digging Deeper into Different Time Periods     101
An Equal Comparison: Fundamental Index versus Equal Weighting     105
Out-of-Sample Results: Small Companies     107
Using the Fundamental Index with Style: Growth and Value Applications     111
Narrowing the Focus     112
Extending the Analysis Back in Time     118
Conclusion     120
Beyond Borders: Fundamental Index Performance in Global Markets     121
Global Markets      122
Multicountry Portfolios     125
Emerging Markets     128
Consistency Counts     130
Concluding Lessons from the Global Markets     132
Has Theory Led the Profession Astray?     135
Will the Real Active Strategy Please Step Forward?     136
The Origins of Cap Weighting     138
Validation of Cap Weighting by Theory     140
40 Years Later: Empirical Results of the CAPM     145
Ockham's Razor Applied     146
Concluding Comments: Theory and the Profession     149
The Basic Criticism: Our Style and Size Tilt     151
Merely a Value Tilt     152
Small-Cap Bias     160
Fama and French Factors     162
Some Big Surprises in Small Companies     165
A Proof Statement in 2007     167
Conclusion     169
Other Common Critiques: Hits and Misses     171
Mining the Data?     171
Costs     177
Is It an Index?     179
Do We Know which Stocks Are Overvalued?     180
How Long Can It Last?     182
Conclusion     185
Why Trust the Fundamental Index Concept?     187
Stock Logic      188
The Present versus the Future: How Often Is Wall Street Right?     193
Why Does Wall Street Get It Wrong?     198
Dynamic Style and Size Exposures: When Do We Want Value and Small Cap?     202
Show Me the Numbers     206
Fundamental Index Strategy versus the Crystal Ball     210
Does the Fundamental Index Concept Work in Bonds?     212
Conclusion     216
Finding Opportunity in a World of Lower Returns     219
What Can We (Rationally) Expect from Our Investments?     220
Forecasting Bond Returns     221
Forecasting Stock Returns     223
Investing in a Low-Return Environment     230
The Outlook for Pricing Errors     232
Could Pricing Errors Actually Increase?     236
Conclusion     238
Using the Fundamental Index Strategy     239
Asset Allocation and the Fundamental Index Strategy     240
Should We Change Our Benchmark?     243
Diversifying the Passive Allocation     244
Different Markets, Different Investors, Different Needs     248
Conclusion     258
Appendix     261
Notes     283
References     295
Index      299