A Comparison Study On The Perfomance Of Cap-Weighted Indexs And Fundamental Indexs

Cap-weighted indexes provide the basis for passive investment strategies designed to capture market performance. However, these cap-weighted indexes are claimed to be sub-optimal because of their tendency to overweight overvalued shares and underweight undervalued shares. Due to this flaw, Arnott, Hsu and Moore bring forward the earth-broken idea of Fundamental Indexation, where weights are assigned to stocks on the basis of non-market measures of a firm's size such as its book value, dividend, revenue, cash flow and employee numbers instead of capitalism. The good performance of Fundamental Indexes is supported by global empirical evidences, and from 2005 to the end of 2009, there are already 70 ETF and Index Funds which are indexed to Fundamental Indexes, whose market capitalism has accumulated to 30 billion U.S. dollars. Meanwhile, however, the development of Fundamental Indexes in the mainland China stays just in the infant period. The FI 50 is the only Fundamental Index with Harvest FI 50 Fund—the only Fundamental Fund which is indexed to it. As to academic research, such studies are scarce and this area hasn't been touched. Because of this, this study is the first comprehensive research that probes into Fundamental Indexation in the mainland China, aiming to hint on the following two questions:(1) How to construct Fundamental Indexes; (2) Is the performance of Fundamental Indexes also better than Cap-weighted Indexes.First of all, according to Arnott, Hsu and Moore (2005), this study chooses 300 companies listed on Shanghai Stock Exchange and Shenzhen Stock Exchange, using dividend, revenue, cash flow and book value as weight to construct Fundamental Indexes. Besides, adopting equal-weighted strategy of the above four data, we also construct a comprehensive index. Second, we compare the performance of Fundamental Indexes to Cap-weighted Indexes such as HS 300, JC 300 and ZB300 Index on the aspect of return, risk, liquidity, trading cost, different period and industry compositions as well as we provide an analysis on the source of the excess return.Finally, based on the above analysis, this study comes to the following conclusions:(1) Fundamental Indexes do exist excess return in the mainland market, and their performance are equal to or better than Cap-weighted Indexes on the aspect of risk, liquidity, trading cost, different period and industry compositions; (2) Among the Fundamental Indexes, book value and cash flow index only exist little excess return while dividend and revenue index and comprehensive index perform much better than the benchmark indexes; (3) An analysis based on Fama-French three-factor model is also conducted to identify the source of excess return. The results show that the excess return of Fundamental Indexes come from riskless factor and value factor, which suggest investment on Fundamental Indexes do bring investors risk-free return.