Fundamental Indexation - A European Investigation

Abstract

Traditional capitalized-weighted index portfolios aim to capture the market performance, and can be considered as a viable investment option for passive investors. However, research suggest that cap-weighted indices are sub-optimal as they overweight overpriced stocks and underweight underpriced stocks. This Master Thesis examines whether the fundamental indexation strategy is superior relative to cap-weighted indexation, covering 15 developed countries in Europe between 1986-2016. The fundamental indices are equally weighted between four non-price based metrics; Book Value, Net Income, Cash Flow and Dividends. The study finds that fundamental indexation generates excess returns adjusted for several risk factors, which is in accordance to comparable research papers. In addition, the findings indicate that the fundamental indices perform better in bear markets relative to the cap-weighted indices’ outperformance in bull markets. The results are persistent through time, which substantiates that fundamental indexation has the features of being a superior indexation method.