Following the criticism surrounding
capitalization-weighting, both academic and practitioner communities have
developed alternative approaches to portfolio construction. We analyze one of
these approaches, fundamentals-based weighting, which identifies the weights of
portfolio constituents on the basis of their market multiples and accounting
ratios. Our analysis is carried out on four fundamentals-weighted portfolios
(FW) based on four different weighting variants, the capitalization-weighted
portfolio (CW), and the equally-weighted (EW) portfolio, from January 2004 to
December 2020, and in two subperiods (2004–2011 and 2011–2020). We find that in
the first subperiod, the EW portfolio shows the highest risk-adjusted
performance, followed by the FW portfolios. In contrast, in the second
subperiod and in the period as a whole, the CW portfolio outperforms the other
portfolios in terms of risk-adjusted performance. Overall, we conclude that
both FW portfolios and the EW portfolio do not exhibit superior results when
compared with the classic CW portfolio. Therefore, we have shown that FW and EW
techniques provide superior risk-adjusted performance only during a period of
exceptional financial turmoil. However, under normal conditions, they cannot be
recommended as a rational investment strategy.
JEL classification numbers: G11, G14.
Keywords: Fundamental weighting, Capitalization
weighting, Equal weighting, Value investing, Indexed investing.