Devoted to understanding the basics and fundamentals of investing

The Wall Street Journal concluded a two part series today, 6/14/06 on their Opinion page on Efficient Markets.  Jeremy J Siegel was today's columnist.  Among the topics he addressed was "Fundamental Indexation."  I was fascinated and spent much of the last few hours getting better educated on the topic. 

Robert Arnott, Jason Hsu and Phillip Moore wrote a paper about a year ago on Fundamental Indexation.  The paper posits that there are better ways to construct an index rather than Market Capitalization (the way most indexes are constructed.)  Based on the paper Mr. Arnott has constructed an index weighting companies based on Sales, Cash Flow, Book Value and Dividends.  It is called the RAFI (Research Affiliates Fundamental Index) and is sponsored by the FTSE among others.  Mr. Arnott’s company, Research Affiliates has also set up some ETFs traded against this index as has PIMCO.  The RAFI index outperforms most market capitalization indexes according to their research.

Of course as with all things on Wall Street, Mr. Arnott and colleagues' paper is not without criticism.  There are several scholarly papers taking exception to this or that part of his theory.

Mr. Jeremy J. Siegel who is a professor at the Wharton School and who is an advisor to WisdomTree Asset Management, Inc. has done additional research.  He advocates using dividends as THE fundamental factor for constructing indexes.  I quote his article, "According to my research, dividend-weighted indexes outperform capitalization-weighted indexes and are particularly valuable at withstanding bear markets."  He feels that dividends are the only fundamental variable that is, "...completely objective, transparent and unable to be manipulated by managers who tinker with accounting assumptions."

I looked up the funds he advises at www.wisdomtree.com and must say I am impressed.  Expenses are low and performance is good.  You may want to check out their prospectus and their Capabilities Brochure.  WisdomTree has a whole family of ETFs available to investors.

According to Mr. Siegel, "The historical data make an extremely persuasive case for fundamental indexing.  From 1964 through 2005, a total market dividend-weighted index of all stocks outperformed a capitalization-weighted total market index by 123 basis points a year and did so with lower volatility.  The data indicated that the outperformance by fundamentally weighted indexes during the same period is even greater among mid-sized and small stocks."

So, it might be worth your while to check out fundamental indexed funds.  They might make you some money.