Very few topics have generated as much debate as fundamental indexing.  Since its introduction in 2005, this debate has taken place in the popular press as well as in academic circles.  Much of the academic debate has been in the Financial Analysts Journal (FAJ), the publication of the CFA Institute.  On one side of the debate are the architects of the index, Rob Arnott and Jason Hsu, Nobel laureate Harry Markowitz, and former FAJ editor Jack Treynor, who stand behind the principles of fundamental indexing.  On the other side, Harvard Business School professor Andre Perold and Morningstar’s director of quantitative research Paul Kaplan have attacked these principles.

Now stepping into the fray is Michael Edesess, who says fundamental indexing is built upon faulty assumptions and faulty mathematics.  According to Edesess, “the central assumption of fundamental indexing, that market cap weighted indexes overweight overpriced securities and underweight underpriced securities, is without merit.”

We had the opportunity to review Edesess’ unpublished paper, Indexation, Noise, and the Size and Value Effects, which systematically deconstructs and disproves the foundation upon which fundamental indexing is based.  A copy of this paper is available by us.  We also spoke with him on July 28, 2008.

Edesess’ brings impressive credentials to the debate.  He is a highly respected mathematician and economist, with a PhD in pure mathematics.  He was a founding partner and Chief Economist of Lockwood Financial Group from 1994 to 2002, and is currently Partner and Chief Investment Officer of Fair Advisors.   He is author of the 2007 book, The Big Investment Lie: What Your Financial Advisor Doesn't Want You to Know.

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