Isn't their basic premise that the large institutional investors who effectively set stock prices are paying too much for certain stocks based on their fundamentals? If so, would you still expect such mispricing to continue now that Arnott et al have shown the light or will this become another backtested strategy that then stops working? 

Another Rick 

Petro,

Thanks for the tip on the article.  Essentially, it reminded me of Rick Ferri's latest book: "The ETF Book."  Rick devotes a number of chapters on the development of market indexes and custom indexes using Index Strategy Boxes and differing index security selections and weightings.  He leaves the impression that many of the benchmark indexes are for the profit of the company creating them and used by fund/investment companies to make them look the best and most profitable compared to their competition.  This would appear to be a confounding factor in the argument over which is best.

ButWait  

retired at 48:

To Chin...very good ending to the above post!  Looks like we meet on common ground.  Good.  See ya...I'll be repositioning north to Saratoga shortly, home of horse racing, ballet, polo and other sundry sports of southern gentlemen.

Hi R48,

We may not always come to common ground, and that if fine. As I have offered earlier, one of my favorite thoughts, "Our delusions are more important to our happiness than reality."

I'm sure taken by itself, this statement sounds condescending, but is not in that manner in which I offer, but only food for thought.

My delusions are going to appear as much reality to me, as anyone else's delusions are going to appear reality to them. It is only through these discussions we can recognize our realities as delusions or reality, and of course, reality is only temporary. Even Einstein never gave up on some of his delusions, even though he recognized them for what they were, or at least he appeared to recognize them as what he called his ‘predetermined prejudices."

Thanks for your time and honest thoughts.

Chin

rpike:

Isn't their basic premise that the large institutional investors who effectively set stock prices are paying too much for certain stocks based on their fundamentals? If so, would you still expect such mispricing to continue now that Arnott et al have shown the light or will this become another backtested strategy that then stops working? 

Hi Rick,

I don't know this is necessarily true. As long as the size and value premium exist, the returns for the fundamental indexes will be higher. If it creates more effective diversification, it can also offer alpha.

All I question is the extent of this small/value premium and diversification. If what Travis Morion offered sometime back holds true, there is no higher probable risks to holding value stocks over a blend index such as the S&P 500. Per what he offered, if you looked at the draw down charts from Ibbotson, the actual tops and bottoms of the bulls/bears, not per annum data, value offered no higher risk than the S&P 500 benchmark. Even if this does not hold true, you have to look back to 1929 to define a higher value risk.

It is possible Fama/French large value such as with DFA or Rydex, or Vanguard's mid value may offer as good, if not better holding than a fundamental weighted index.

More than just an EMH based question on this, we have to ask how much we can depend on historic data period. Looking at the historic data itself, returns and correlations vary according to the period you look at.

If we thought we could go with historic data, what some call data mining, the retiree could go with 50/50 small value/commodities and depend on drawing 7% from their retirements. I think most in their right minds would not place that much confidence on this strategy. I don't see why they would place any more on a fundamental weighed index.

I think what this fundamental index is pointed to is for those who still believe in EMH, trying to find a way to improve on total markets. If they believe in EMH to the point of not value tilting, maybe fundamental indexing is a way to sway them in a more rhetorical way.

If 80 years worth of data offers only theory, I would imagine this could be looked at as only theory as well.

Who knows?

Chin