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Fundamental indexation: rebalancing assumptions and performance

Fundamental indexation: rebalancing assumptions and performance

15-09-2010 | Research

Rebalancing assumptions can have a significant impact on the performance of a fundamental index. We propose blending multiple indices, rebalanced annually but at different dates, to construct a more robust fundamental index without increasing turnover.

  • David Blitz
    David
    Blitz
    Chief Researcher
  • Bart van der Grient
    Bart
    van der Grient
    Reseacher
  • Pim  van Vliet, PhD
    Pim
    van Vliet, PhD
    Lead Portfolio Manager Conservative Equities

Speed read

  • Index performance is highly sensitive to rebalancing assumptions
  • Performance ambiguity is an undesirable feature of an index
  • Blending multiple indices can lead to a more robust index
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In this article,1 we show that the performance of a fundamental index with annual rebalancing, as proposed by Arnott, Hsu, and Moore (2005), can be highly sensitive to the subjective choice of when to rebalance. For the year 2009, for example, a fundamental index rebalanced every March outperformed the capitalization-weighted index by over 10%, whereas a fundamental index rebalanced every September underperformed.

We provide intuitive and statistical evidence in support of the hypothesis that if two fundamental indices diverge, they do not subsequently tend to mean revert (i.e., the gap is likely to be permanent). The performance ambiguity is an undesirable feature for an index that is used for benchmarking purposes.

We introduce the idea of blending multiple underlying fundamental indices, each one rebalanced annually but at different dates, as an example of how to construct a more robust fundamental index without increasing turnover.

1Blitz, D.C., Van der Grient, B. and Van Vliet, P., 2010, ‘Fundamental indexation: rebalancing assumptions and performance’, The Journal of Index Investing.

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