The Fundamental Index® methodology was developed to address the structural return drag created by traditional capitalization-based indexing strategies, which systematically overweight overpriced securities and underweight underpriced securities. According to our research, the return drag associated with this structural flaw is 2% to 3% per annum.

The return drag of capitalization-weighted indexes is caused by the linkage between a company’s stock price and its weight in the index—that is, a company whose stock price is overvalued (undervalued) will have too high (low) a weight in the index, causing it to underperform (outperform) as the stock price corrects.

In a perfectly efficient market, where stock prices are always accurate measures of a firm’s future value, capitalization would be an acceptable way to weight stocks in an index. If, on the other hand, prices are not perfect measures of a firm’s future value, capitalization-weighted indexes will experience a return drag from holding too much of an overvalued stock and too little of an undervalued stock.

The Fundamental Index methodology has received numerous awards for innovation and index provider of the year.

Overview | Methodology | Performance | RAFI® FAQ | Awards