Today, the value versus growth dispersion is the widest it has been since 2000.  Today is a wonderful time to embrace value strategies, and, because of the wide dispersion in valuation multiples, a fundamental index portfolio has recently become a deep value strategy. 

The fundamental strategy self-adjusts when dispersion is huge, as it is today, trimming growth and adding value exposure.  If 2009 and 2010 are outstanding years for value stocks – which probably will be the case – then fundamental index strategies will turn out to be a very valuable part of our tool-kit.

Most folks will opt to “wait and see” because of the last year of underperformance, but fundamental indices are priced to add exceptional value.

No, I don’t think the alpha potential has dissipated.  To the contrary, I think today offers the richest potential for fundamental index alphas since the peak of the tech bubble in 2000.

You will know the alpha potential is fading when the dispersion of valuation ratios narrows … and remains that way.  In 2005 and 2006, this dispersion narrowed but didn’t stay there.  It widened, hugely, in 2007 and 2008.  This dispersion is like a spring.  If the spring gets squashed by vast adoption of the fundamental index concept, and if the dispersion of valuation multiples then stays narrow, the fundamental index concept will have lost much of its edge.

The underperformance of fundamental index portfolios in 2007 and 2008 was largely a US phenomenon; the US was the outlier, just as it was an outlier on the up side in 2000 and 2001; that underperformance can be traced directly to the underperformance of value relative to growth, which we already discussed, and the widening dispersion of valuation multiples. 

The spring is very much intact.  As long as you have that spring, the best time to embrace the idea is when it is least comfortable - when dispersions are very wide and value has underperformed.

My largest single investment is in a long/short fundamentally weighted strategy that we run ourselves.  We are long the companies that are most heavily weighted in the fundamental index, relative to their market cap, and short those that are most heavily weighted in the cap-weighted index, relative to their fundamental economic scale.  We invest where the gap between the two indices is the most extreme.  The effect is much the same as being long the fundamental index and short the S&P 500, leveraged ten-to-one. 

A very significant part of my net worth is invested in the fundamental weighting concept through this long/short strategy.  I have no significant investments in the fundamentally weighted funds or ETFs.  I am more focused on buying the alpha of the index, rather than the beta of the stock market, where I remain a little bearish to this day.