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Fundamental Index Funds Beating Traditional Benchmarks

To appreciate why the fundamental funds shined in recent years, consider how the S&P 500 and Schwab U.S. Large Company Fund differed during the downturn. As the credit crisis unfolded, financial stocks collapsed. In the S&P 500, the financial weighting dropped from 17% of assets in 2007 to 10% in the spring of 2009. But revenues of financial companies such as JPMorgan (JPM) and Bank of America (BAC) were still enormous. As a result, the weighting of financial stocks in the Schwab fundamental fund held steady at about 20%.

In 2008, the decreasing financial holdings helped to protect the S&P, which lost 37% for the year, and outpaced the Schwab fund by 3 percentage points. But when financials roared back in 2009, Schwab shifted into the lead, gaining 42% for the year, and outdoing the S&P by 16 percentage points.

For this year, Schwab has returned 10.6% and outpaced the S&P by 3 percentage points as the recovery of financial stocks continues. "Fundamental funds tend to do best when markets are volatile and share prices move away from the fundamental values," says Jason Hsu, chief investment officer of Research Affiliates.

Part of the appeal of many fundamental funds is that they have a bias for value stocks, which tend to outperform the market over the long term. Consider RevenueShares Large Cap, which weights stocks solely on revenues. Holdings in the fund's top 10 include Ford Motor (F) and Citigroup (C), companies with big revenues and relatively modest market capitalizations.

In its top 10, the fundamental fund has no computer or software stocks. In contrast, the top 10 holdings of the S&P 500 include technology blue chips, such as Apple (AAPL), which has a big market capitalization and relatively small revenues. "The weightings of the top 10 holdings in the S&P 500 are based on the speculation and hope of investors," says Sean O'Hara, president of RevenueShares. "We base our weightings on the reality of revenues."

A Better Mousetrap

In recent years, these fundamental index funds have outdone the traditional benchmarks.





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Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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