Revisiting Fundamental Indexation: A Deep Dive into Revenue

Abstract

The capital shift to passive investing is among the most important evolutions in investment management in the last four decades. Striking in its magnitude and relative speed of adoption, the significance for asset management, and investors more broadly, is still not well understood. Those switching to passive investing have predominantly turned to indexing, with broad-based market and asset class indices seeing the vast majority of these inflows. Moreover, indexing has been dominated by a simple market-capitalization weighting mechanism. In this study, we bring new evidence to bear on the optimal weighting of indexing strategies for those wanting broad-based exposure to equities in both the U.S. and abroad. In particular, we document three main findings: (1) along with several other methodologies, revenue weighting has outperformed market-capitalization weighting in both absolute returns and return per-unit-risk over the past 40 years in the U.S., (2) revenue weighting provides more stable exposures to industries over this period, and (3) while the international evidence is more mixed, in developed markets and in the largest emerging market economies, revenue weighting appears to dominate market-cap weighting in terms of return and return per-unit-risk over the recent history through present-day. Given the totality of evidence, revenue weighting appears to be a fitting alternative when considering an allocation to broad indexation approaches.