State Street Global Advisors (SSgA) has teamed up with Global Wealth Allocation (GWA) to launch a new "fundamental indexing" strategy for clients in Australia. The new SSgA Wealth Weighted Global Equities Index Strategy marks the first foray by SSgA into the fundamental indexing movement, championed in the U.S. by Rob Arnott's Research Affiliates (RAFI) group. With SSgA's huge institutional reach, its entry into the fundamental indexing space - even in a far-off market like Australia - represents a significant development for the industry.

While it doesn't get the press that Arnott receives, SSgA's partner in this venture, GWA, is an established player in the fundamental indexing market.  The group's strategies have been used for more than half-a-decade to manage pensions at places like UPS and Honeywell.

While the specifics of the strategies differ, all fundamental indexing approaches share a similar goal: to beat a market-cap-weighted index by 2+ percent per year by using fundamental metrics rather than market capitalization to weight stocks in the index.  The idea is to avoid overweighting overvalued stocks. The SSgA/GWA approach uses earnings, cash flow and book value as its metrics, while other fundamental indexes use a different mix; Arnott, for instance, uses sales, dividends, cash flow and book value. Academic studies have considered everything from revenues to number of employees. According to SSgA's product development team in Australia, however, the exact breakdown doesn't actually impact returns in a substantial way.

"It seems that the removal of market price from the weighting equation is what drives the returns, rather than exactly which fundamental financial variables are used to build the portfolio," aid Jonathan Shead, product engineer at SSgA Australia.

The new SSgA strategy includes all the stocks within the FTSE Developed Market universe: over 2,000 companies in 23 developed markets. The fundamental screen doesn't cut out individual stocks, no matter how "overvalued" they may be; rather, it aims to minimize their weight in the portfolio.

Shead expects the strategy to appeal to long-term investors like endowments, charities and insurance funds, who are looking for low-risk, core-market exposure.

"Market cap indexing is still pre-eminent and we don't expect this to change. This product will not cannibalize market cap indexation, but seeks to enable investors to capture return in a different way," said Shead.

The strategy was launched first in Australia to meet an identified local demand.  The RAFI strategies already have a significant foothold in the U.S. and Europe, but SSgA could enter those markets too if demand materializes.  If so, SSgA's huge reach in the industry could represent a real challenge to RAFI and other fundamental indexers like WisdomTree.