THE CONTROVERSY IN FUNDAMENTAL INDEXATION: WHY BOTH SIDES OF THE ARGUMENT ARE (MOSTLY) CORRECT

Michael Dempsey

We examine the contribution of “noise” to the theoretical underpinnings of fundamental indexation (FI). Although we argue that market capital-weighted indexes do not incur a “structural drag” due to noise as claimed by the proponents of FI, we conclude, nevertheless, that noise as advanced by FI offers a potential for achieving superior returns to those achieved by market capital-weighted indexes. As such, FI represents an important insight to our understanding of asset pricing.