GLOBAL - More than a third of pension funds prefer fundamental indices over free float market capitalisation indices, a clear indication that the concept is gaining sway.
When asked which indices they preferred, 38% of Global Pensions’ panel of 100 pension funds worldwide chose fundamental indices.
However, free float market cap indices remain the dominant form of indexation, with 50% of pension funds preferring market cap over capped indices (12%) and fundamentals, or wealth-weighted indices.
Rob Arnott, chairman of Research Affiliates, which pioneered the concept of fundamental indexation, described the results as startling. “This concept was rolled out in the form of a preliminary draft article barely more than two years ago, as a published article less than 18 months ago, and the indexes were first published by FTSE less than a year ago,” he said.
“But, even more shocking is that there’s not even $5bn invested in this concept (up from $800m at the start of the year). If 38% think this is a better idea, why do they not use it? This survey suggests the likelihood of truly explosive growth in the years ahead.”
Jerry Moskowitz, managing director, FTSE Americas added: “We thought fundamental indices would be seen more as a complement to other indices so the fact that 38% see them as a replacement is huge.”
Fundamental indices seek to strip out the large cap bias and vagaries of price in free float market capitalisation indices. Such indices, constructed by ranking and weighting companies based on financial data such as sales, cash flow, book price and dividends, revolve around the premise that the largest stocks by market cap are not always the best performing stocks.
Moskowitz estimated more than $10bn in assets could be in the fundamentals area by next year.
“The amount in indexed funds is around $2.5trn so even if we get to $10bn we’re still only in a small percentage of the overall amount of funds that are being attracted to index funds that are mostly in the free float area,” Moskowitz said. “I think we have tremendous growth ahead of us, there’s plenty of capacity.”
Pension funds have taken the plunge include the SEK190bn (e20.5bn) AP2, which in July allocated US$600m of its North American equities to the
Re-search Affiliates Funda-mental Index (RAFI) and flagged up further allocations. In February the US$207bn California Public Employees’ Retirement Sys-tem (CalPERS) said it would invest $1bn in an internally managed equity portfolio tracking the RAFI.
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