Analysis of Fundamental Indexation as an Efficient Approach to Active Investing

Abstract

For many years researchers have been arguing on whether active investing is superior to passive investing by giving theoretical and empirical rationale underlying their beliefs. A desire to over-perform passive investing by utilising fundamentally-justified methodology has led to the development of numerous active and semi-active strategies, such as Fundamental indexation established in 2005 by Arnott et. al. In their research, the authors suggested constructing investment portfolios by assigning the weights of each asset concerning the values of its fundamental indicators. This approach has met heavily critique for the lack of theoretical rationale, by not being able to connect the values of selected fundamental indicators to the future performance of the portfolio. In this research, the thesis of passive investing superiority has been challenged by constructing an active investing strategy based on Fundamental Index described by Arnott et al. (2005) - Modified Fundamental Index and testing it on the UK stock exchange companies. The resulted portfolio showed superior performance compared to the cap-weighted index while also having lower risks and higher diversification. Also, I suggested some ideas for further research concerning MFI.