Not quite.  I view it as structural in today’s markets and the markets that are reasonably plausible in the years ahead.  If price is an unbiased estimator of true future fair value, and if errors are symmetric around price, then the market is efficient.  No departures from capitalization weighting will have structural alpha.  In this “efficient markets” world, there may be accidental alpha, but not structural alpha.

Let’s flip that around.  Assume the unknowable fair value is the anchor, and the market is constantly looking for it.  The market moves around, as facts become known and circumstances change.  I think this represents a more plausible representation of the real world than the efficient markets view, which is the utterly dominant view.  This view is more plausible because most practitioners acknowledge there is a fair value, although we don’t know what is.  And the market constantly seeks that fair value, for which price is a reasonable best guess.  If the error around the fair value is symmetric, it must be negatively correlated with price:  the higher the price or the P/E ratio, the more likely it is that the price is too high.

Now, let’s suppose that growth stocks are systematically priced at a discount to fair value, and value stocks at a premium.  In other words, the growth stocks carry a premium multiple, but it’s too small a premium … they’re too cheap and the value stocks are too expensive.  If we have this peculiar pricing, to an extent just large enough to offset the mean reversion in pricing noise, then the alpha of any valuation-indifferent approach would be neutralized. 

Push this to an extreme. Suppose valuation multiples (e.g., P/E and P/B ratios) are the same for all assets.  Then cap-weighted and fundamentally-weighted indices would perform identically and the alpha would be zero.  Then any decent analyst who could discern future growth, with better than random skill, could win by identifying the companies with greater growth prospects.

The more fundamental index strategies are embraced, and the more money flows into these strategies, the more the extreme of the valuation range will be pulled in and the narrower will be the dispersion of valuation multiples.  As that happens, the fundamental index concept should deliver smaller and smaller alpha.

But it is hard to imagine that happening without trillions of dollars of investment.  And it’s pretty clear that the transition from today’s world to this hypothetical world of too-narrow dispersion of valuation multiples would be an immense boon to the early adopters of fundamental index strategies.

Regarding the last part of your question, the answer depends on how you define drag.  If the performance drag of a portfolio is defined relative to the market, then of course cap-weighting can’t have a drag, because it is the market.  But, suppose drag is defined relative to the opportunity set. If prices constantly move to seek fair value, there is a mean reversion in that error.  There are also constant new shocks, so the size of the error remains that same.  Long-term returns exhibit this serial correlation.  On a rolling ten-year basis, returns are negatively correlated with the prior decade to a surprising extent, about -40%.  We are seeing that right now, in the current decade.  These mean reverting errors are the key source of alpha in fundamental index portfolios. 

I have the opposite perception.  The short term alpha of fundamental weighting is directly tied to the growth-value cycle.  When growth is winning, fundamental weighing has a headwind.  Reciprocally, cap-weighting has a tailwind when you have a growth dominated market.

From 2000 to 2006, fundamental weighting was utterly dominant.  It benefited both from a market that was rewarding value strategies and from contra-trading against excesses in the market.  This is our rebalancing mechanism at work.  When regressed against the Russell Value and Russell Growth indices, fundamental index returns have a beta tilt towards Russell Value, but they also have an alpha relative to both that accounts for three-fourth of its value added.  That alpha can be swamped by the impact of the value tilt, depending on whether value is winning or losing.  The reciprocal happened in 2007 and 2008, when value lost, big time. 

The magnitude of the value tilt in the Fundamental Index® portfolios will depend on the dispersion of value multiples.  If this dispersion is narrow, fundamental index strategies may not have an advantage.  But it is brilliant when value is cheap.