An alternative fundamental weighting scheme based on enterprise value multiple

Abstract

Fundamental indexing has been proposed as a semi-active strategy that outperforms classical market-capitalization weighting. This paper proposes an alternative weighting scheme based on the enterprise value multiple (EM) that integrates the market value of equity with debt information. Over the period 1972–2017, the EM-weighted index has lower tracking error and a higher information ratio when compared with a composite fundamental index in US equities. The EM index generates an information ratio of 0.71 which is larger than the composite fundamental index. The EM index also generates significant alpha that exceeds the traditional fundamental index using several asset pricing models. Further tests show that debt information plays an important role in the outperformance of the alternative weighting scheme.