While traditional index funds are constructed according to market capitalisation, ‘fundamental index’ strategies use a range of other measures including book value, cash flow, dividends or sales.
Vanguard principal for marketing strategy and communications Robin Bowerman said he had no issue with the concept of fundamental investing per se.
“If people want to take a bet against the market that’s absolutely fine – people take active bets all the time,” he said.
“Our concern is that it’s called ‘indexing’, because indexing really is about capturing the whole market or a segment of a market return.”
The risk for investors is that they may not understand the active risk they are taking when they put their money into a smart beta strategy, he said.
Because indexing has enjoyed “very strong growth in the last 15 years, both [in Australia] and the United States”, Vanguard is sceptical that the relatively new phenomenon of fundamental indexing may be “more about marketing than indexing”, said Mr Bowerman.
“It’s about packaging something up as indexing when really it’s an active bet against the market return. You may outperform or you may underperform – it depends [which measure is used],” he said.
But according to Andrew Francis, who is the chief executive of Colonial First State subsidiary Realindex Investments, smart beta strategies are simply a "better way of investing".
Traditional indexing results in investors putting more money into the most expensive companies and less into the undervalued companies, he said.
“No one prescribes that you can only do indexing one way. What we do is weight it by company fundamentals,” said Mr Francis.
“You don’t make money by being in a popularity contest. You make more money by being contrarian … [and] having a rules-based process allows [us] to be very disciplined.”
Realindex attempts to “break the link between price and portfolio weight”, he said.
Mr Francis said much of the debate around fundamental indexing has “gone away” in recent years and there is now a level of acceptance of smart beta.
“The most important thing we emphasise is the return profile will be different to the market. If you’re measuring it relative to the market, there will be periods of underperformance,” he said.
The challenge is to educate investors so they stay with the strategy for the long term, said Mr Francis.
Realindex, which recently reached its fifth anniversary with $7 billion in funds under management, has outperformed its relevant indexes since inception.
Since inception, the Realindex Australian Share fund outperformed the ASX200 by 1.38 per cent per annum; the Australian Small Companies fund outperformed its index by 7.04 per cent per annum; the Global Shares fund outperformed its index by 0.39 per cent per annum, and the Global Shares Hedged fund outperformed its index by 0.84 per cent per annum.
