Skip to Main Content
HBS Home
  • About
  • Academic Programs
  • Alumni
  • Faculty & Research
  • Baker Library
  • Giving
  • Harvard Business Review
  • Initiatives
  • News
  • Recruit
  • Map / Directions
Faculty & Research
  • Faculty
  • Research
  • Featured Topics
  • Academic Units
  • …→
  • Harvard Business School→
  • Faculty & Research→
Publications
Publications
  • November – December 2007
  • Article
  • Financial Analysts Journal

Fundamentally Flawed Indexing

By: Andre F. Perold
  • Format:Print
ShareBar

Abstract

A new theory of finance is being advanced as providing definitive proof that holding stocks in proportion to their market capitalizations is an inferior investment strategy. The claim is that capitalization weighting necessarily invests more in overvalued stocks and less in undervalued stocks. Dubbed the "noisy market hypothesis," the theory is being used to advocate investments in non-cap-weighted (sometimes called "fundamental") funds and indices. Unfortunately, there is a fundamental flaw in the logic. The "theory" is seeking to position an active management strategy in a passive management framework. And it asserts rather than derives the inferiority of capitalization weighting. The assertion, moreover, is false. Bottom line? Capitalization weighting does not impose an inherent performance drag. This article lays out what the noisy market hypothesis is claiming and then explain why the conclusion it reaches about the inferiority of capitalization weighting is incorrect.

Keywords

Investment; Capital Markets; Financial Strategy; Stocks; Financial Management; Valuation

Citation

Perold, Andre F. "Fundamentally Flawed Indexing." Financial Analysts Journal 63, no. 6 (November–December 2007). (

Winner of Graham and Dodd Best Perspectives Award For excellence in financial writing​

.)
  • Find it at Harvard

About The Author

Andre F. Perold

→More Publications

More from the Author

    • April 2014
    • Faculty Research

    Oceanbulk Maritime S.A. (B)

    By: Andre F. Perold
    • July 2013 (Revised June 2014)
    • Faculty Research

    Oceanbulk Maritime S.A.

    By: Andre F. Perold
    • July 2013
    • Faculty Research

    B. Zaitz & Sons Co. Farmland Investing

    By: Andre F. Perold
More from the Author
  • Oceanbulk Maritime S.A. (B) By: Andre F. Perold
  • Oceanbulk Maritime S.A. By: Andre F. Perold
  • B. Zaitz & Sons Co. Farmland Investing By: Andre F. Perold
ǁ
Campus Map
Harvard Business School
Soldiers Field
Boston, MA 02163
→Map & Directions
→More Contact Information
  • Make a Gift
  • Site Map
  • Jobs
  • Harvard University
  • Trademarks
  • Policies
  • Digital Accessibility
Copyright © President & Fellows of Harvard College