ARM May Edition

Academic Research Monitor

May 2009 Edition

Covering key financial market related academic research produced over the last month

P

ortfolios Weighted by Repurchase and Total Payout

On 20 April Standard & Poor’s published itsyear-end scorecard on the performance of actively managed investment funds versusthat of its own passive indexes. Over the 5years to 2008 active fund managers wereoutperformed by 72% (large caps), 79% (midcaps) and 85% (small caps).Such out performance is not new and theindustry promoting passive index investinghas accordingly grown vast since its humble1976 beginnings when John Bogle launchedthe Vanguard 500 Index Fund. Indeed,having comprehensively smoked the activecompetition for so long attention in recenttimes has focussed on

which

method of passive indexing is best.Since 1976 it has been the weighted bymarket value approach that has dominated.But research in 2004 by Arnott, Hsu andMoore (“Fundamental Indexation”)demonstrated that a fundamental weightingapproach using, for example, assets, or dividends, or sales, or earnings etc -delivered consistently superior returns withless turnover and higher Sharpe ratioscompared to portfolios weighted soley bymarket capitalisation.Within a year of publication the alreadytrillion dollar indexing industry saw a spurtof new ETF launches on the back of thefindings. And so, in the natural order of things, a new paper has been published by aseparate team of academics further exploringand finessing other potential styles of fundamentally weighting portfolios. Theteam of Francis, Hessel, Wang and Zhangtest three such new approaches in their “Portfolios Weighted by Repurchase andTotal Payout” paper based on sharerepurchases, total payout and earningsretention. The conclusion? The sharerepurchase method produces higher excessreturns, bigger Sharpe ratios and larger alphathan anything previously analysed in theearlier Arnott, Hsu and Moore paper.It is fascinating reading building on whatmany, including its authors, regard asgroundbreaking research into a radicallysuperior form of portfolio indexing.However, an alternative and more down toearth assessment is that the new approachsimply incorporates an appropriate emphasison those equity characteristics that havehistorically demonstrated out performance:namely, value ratios. Recognition of thevalue premium in a new, diversifiedindexation product that retail and professional investors can take advantage of (for new ETFs will surely follow the paper in due course) is a welcome – butincremental – evolution.References & further reading:Francis, Jack Clark, Hessel, Christopher,Wang, Jun Jonathan and Zhang, Ge.

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Editor's choice

"having comprehensivelysmoked the activecompetition for so longattention in recent timeshas focussed on whichmethod of passive indexingis best"

May 2009

(...References continued...)“Portfolios Weighted by Repurchase andTotal Payout” (April 4, 2009)Fama, E., and K. French.“The ValuePremium and the CAPM.”

Journal of Finance

, Vol. 61 (no. 5, 2006): pp. 2163-2185.Standard & Poor's Indices Versus ActiveFunds Scorecard, Year End 2008Arnott, Robert D., Hsu, Jason C. and Moore,Philip.“Fundamental Indexation”

Financial Analysts Journal

, Vol. 61 (no. 2, 2005): pp.83-98.Siegel, Jeremy J. (2006),“The ‘NoisyMarket’ Hypothesis”,

Wall Street Journal

,June 14, A14.

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May 2009

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