Global Pensions talks to David Morris of GWA about fundamental indexing
Having said that, the first question to consider is to which of two broad categories does any alternative index product belong: Non-price indices or non-market capitalisation indices?
Within non-price indices there are those that re-weight existing performance indices and those that simply rank stocks to create a new index. GWA re-weights existing FTSE indices using accounting measures of wealth. Therefore, we are accepting the index provider’s definition of the market which ensures that all our portfolios are scalable like those of FTSE.
Non-price indices that simply rank securities to provide a predetermined number of constituents, say 1,000 or 1,500, without considering liquidity or index membership, would be less scalable.
In both types of non-price indices, various financial statement items are used so it is imperative to question the rationale for the ones chosen. GWA chooses metrics consistent with traditional economic theory about company valuation based on discounted income.
Non-market cap indices are very different from non-price indices. They incorporate security prices but avoid market capitalisation weighting. These indices may aim to exploit well known market inefficiencies. Alternatively, they may aim to minimise price volatility and correlation among single securities or clearly defined groups of securities like sectors or industries.
Global Pensions: Because they are not purely replicating market-cap indices, many of these blur the lines between active and passive strategies. Do you consider this an active or passive strategy? Why?
David Morris: Some are active and some are passive.
In the late 90s our wealth weighted portfolios were distributed to implementers quarterly, in spread sheets, not daily as indices. Those portfolios had all the features of a market cap index: a rules-based process with no human intervention, replicable and transparent. Today we publish ground rules and FTSE sends implementers a daily index of weights rather than GWA sending a quarterly spread sheet.
