Because the book was published only Tuesday, we’re still reading it and should publish a full review as early as next week.
From Greenblatt’s interview with Morningstar, however, we already have a pretty good idea of what the book is about and what the motivation is behind it.
The “big secret” is value-weighted indexing.
Most indices, like the S&P 500 and Russell 3000, are weighted by market cap. That means that for every dollar you invest in them, the largest-cap stocks get more pennies then the smaller-cap stocks.
For example, if you invest $100 in a S&P 500 index fund (SPDR S&P 500 ETF(SPY_) is a popular one), about $3.48 is invested in ExxonMobil(XOM_), the largest-cap stock in the index, while about $2.52 is invested in Apple(AAPL_), the second largest, and so on.
Greenblatt believes that weighting the indices by value parameters, such as the operating earnings yield and return on tangible capital used by MFI, produces better stock investingresults.
In the Morningstar interview, he says that market-cap weighting removes about 2% of annual returns as opposed to equal weighting (where money is spread evenly among all stocks in an index).
A quick Google search will net you dozens of studies corroborating that fact, and it makes intuitive sense as well: Very large-cap stocks have more limited growth avenues and are more appropriately priced in general.
But the real upside is by placing bigger bets on firms in the index that rank higher by value parameters. Greenblatt contends that this adds 4%-6% of return a year over market-cap weighting over the long term. Furthermore, back-testing shows that this method is not any riskier or volatile than a market cap weighted solution.
To implement this system for investors, Greenblatt and his partners at Formula Investing have created “managed indexed” mutual funds. The U.S.-based ones use a universe of the 1,400 largest U.S.-listed stocks. Formula Investing U.S. Value A (FVVAX) chooses 800 to 1,000 of these, and the Formula Investing U.S. Value Select A (FNSAX) selects 75 to 120 of them. Both funds base their selections using MFI parameters and rebalance themselves frequently. There are also international variants of these two funds, choosing stocks in 26 countries outside of the U.S.
But the real upside is by placing bigger bets on firms in the index that rank higher by value parameters. Greenblatt contends that this adds 4%-6% of return a year over market-cap weighting over the long term. Furthermore, back-testing shows that this method is not any riskier or volatile than a market cap weighted solution.
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