TY - JOUR T1 - Fundamental Index<sup>®</sup> Fixed-Income Performance: <em>It’s</em> <br/> <em>All in the Price</em> JF - The Journal of Index Investing SP - 75 LP - 80 DO - 10.3905/jii.2011.1.4.075 VL - 1 IS - 4 AU - Shane D. Shepherd Y1 - 2011/02/28 UR - https://pm-research.com/content/1/4/75.abstract N2 - In the five years since the launching of Fundamental Index® strategies as live portfolios, the effectiveness of the strategy and source of its outperformance have been strenuously debated. The initial research by Arnott, Hsu, and Moore presented the concept as a simple quantitative way to sidestep a crucial shortcoming of cap-weighted indexing. Capitalization-weight traditionalists, following in step with the efficient markets hypothesis, enter into the argument with the belief that excess returns for any strategy must be compensation for the assumption of extra risk. In their mind, a Fundamental Index approach outperforms merely due to exposure to a size or value premium. Standing contrary to the EMH are proponents of a noise-in-price model, who believe that an ability to systematically take advantage of a mispricing effect drives the excess returns. In this article, the author examines the characteristics of price returns in the Fundamental Index fixed income strategies and shows evidence that supports the noise-in-price model. A fixed income portfolio that earns higher return due to a risk premium should show a higher yield and typically a higher income return at the expense of greater defaults and lower price return. However, a noise-in-price model suggests that outperformance will come about from systematic rebalancing and contra-trading against noisy price movements, which is manifested as a high price return. The findings show that the excess returns to Fundamental Index fixed income portfolios are due entirely to price corrections and not due to exposure to higher risk factors. This supports a noise-in-price model as the driver of excess returns rather than exposure to higher amounts of risk.TOPICS: Mutual fund performance, risk management, style investing ER -