Defining the best fundamental indexing strategy from 1998 to 2015.

Abstract

In this paper, we try to establish the best -smart beta- fundamental metric among the dividend metric and the profit metric. Regarding the dividend metrics, we built a pure dividend, a dividend yield and net payout indexes. For profit metrics, we decided to focus on the gross profitability, the operating profitability and the cash operating return on assets metrics. The covered period runs from the 1st of January 1998 to the 1st of January 2015 and covers two expansion and two recession cycles. We used the Nasqad composite of March 2016 as a basket of stocks in order to construct our indexes. In our quest to find the best metric among those we chose, we decided to apply different weighting and sorting methodology to our indexes. The weighting strategy we tested are respectively the fundamentally weighted method and the equally weighted method. Regarding the sorting of data, we decided to apply to them the last data available method and trailing five-year average method. The latter is assumed to smooth the data in order to reduce the high cyclical performance (Arnott, Hsu and Moore, 2005). At the end of the day, we ended up with four different indexes for each studied metric. Then, we have computed some of the most important performance ratios for each index that we built and we plotted their cumulative monthly returns. These results helped us to compare the indexes regarding their risk-adjusted returns and to establish the indexes with the best potential. Afterwards, we regressed each of our indexes on the Fama & French 4-factor to which we also added the VIX. At the end of the day, we analyze whether our indexes were tilted towards market, size, value, winner and implied volatility factor. Ultimately, we conclude that the trailing five-year average operating profitability index, that is equally weighted, outperforms the other dividend metrics as well as the other profit metrics.