THE HISTORY OF FUNDAMENTALLY WEIGHTED INDEXATION
The motivation for fundamentally weighted indexation began in the in-
ternational markets. In the 1980s, when Japan’s stock market was in a
bubble, many investors with internationally diversified portfolios were
seeking a consistent way to reduce the weight of Japanese stocks. At that
time Morgan Stanley Capital International (MSCI) formulated an inter-
national index that weighted each country by GDP rather than market
capitalization and fortunately reduced the allocation to Japanese
stocks.^21
In 1987 Robert Jones of Goldman Sachs’s quantitative asset man-
agement group developed and managed a U.S. stock index in which the
weights of each firm in the index were corporate profits. Jones referred
to his strategy as “economic investing” because the proportion of each
firm in the index was related to its economic importance rather its mar-
ket capitalization.^22 Later David Morris, founder and CEO of Global
Wealth Allocation, devised a strategy that combined several fundamen-
tal factors into one “wealth” variable.^23
In 2003, Paul Wood and Richard Evans published research on a fun-
damentally based approach that evaluated a profit-weighted index of
the 100 largest companies.^24 In early 2005, Robert D. Arnott of Research
Affiliates, along with Jason Hsu and Philip Moore, published a paper in
theFinancial Analyst Journalentitled “Fundamental Indexation” that ex-
posed the flaws of capitalization-weighted indexes and laid the case for
fundamentally based strategies.^25 In December 2005, the first fundamen-
tally weighted ETF was launched by Powershares to track an index con-
structed by Research Affiliates based on sales, cash flows, book values,
and dividends.^26 Six months later, WisdomTree Investments launched 20
ETFs based on dividends and followed up in 2007 with six more based
on earnings.^27
356 PART 5 Building Wealth through Stocks
(^21) Henry Fernandez, “Straight Talk,” Journal of Indexes, July/August 2007.
(^22) Robert Jones, “Earnings Basis for Weighting Stock Portfolios,” Pensions and Investments, August 6,
1990.
(^23) To see a complete set of the FTSE/GWA Index rules, go to http://www.ftse.com/Indices/FTSEGWA
Index_Series/Downloads/FTSE_GWA_IndexRules.pdf.
(^24) Paul C. Wood and Richard E. Evans, “Fundamental Profit-Based Equity Indexation,” Journal of In-
dexes, Second Quarter 2003.
(^25) Arnott, Hsu, and Moore, “Fundamental Indexation.”
(^26) For a full description of the FTSE/RAFI Index methodology, visit [http://www.ftse.com/Indices/FTSE](http://www.ftse.com/Indices/FTSE_)
RAFI_Index_Series/2006Downloads/FTSE_RAFI_Indexrules.pdf.
(^27) As a matter of full disclosure, I am the senior investment strategy advisor at WisdomTree Invest-
ment, Inc., a company that issues fundamentally weighted ETFs.