weighted indices. Response: Fundamentally based indices do have a higher turnover than capitalization weighted indices. However, the turnover is so low that its costs do not substantially affect returns. For example, the U.S. Fundamental Index 1000’s turnover ranges between 10 and 12 percent per annum versus 6% for an annually rebalanced capitalization-weighted index of the largest 1000 stocks. Furthermore, fundamentally based indices experience most of their turnover in large, liquid stocks while capitalization-weighted indices experience most of their turnover in small, illiquid stocks. Fundamentally based index funds have higher expense ratios than the traditional capitalization weighted index funds. For example, the Powershares fundamentally based ETFs have an expense ratio of 0.6% (the U.S. index ETF has an expense ratio of 0.39%) while the PIMCO Fundamental IndexPLUS TR Fund charges 1.14% in annual expenses. In comparison, the Vanguard 500 Index Fund "Investor shares" ($3,000, minimum investment) charges 0.18% per annum, whereas the Vanguard 500 Index Fund "Admiral shares" ($10,000, minimum investment) charges 0.05% per annum. Response: Fundamentally based ETFs do have higher expense ratios than capitalization-weighted ones but the 2 to 2.5% of additional returns per annum far outweigh the additional expenses incurred. Fundamentally based indices ignore information from the variance-covariance structure of returns. Thus, the covariance structure is under-utilized despite the fact it has some predictive power - "Past correlations predict future correlations much better that past returns predict future returns." Notes External links FTSE RAFI Index Series Financial markets Stock market indices