I agree that is what Vanguard argues, but I am not sure I agree that what they are saying is the whole story.
Certainly a traditional style based approach will lean towards certain industries. What is wrong with targeting the more valuey companies in a less valuey industries?
The argument against a traditional style based approach is that the value premium is mean reverting, and by only focusing on "value" stocks, you may not be actually catching the full value premium. For instance if two companies have the same price/book and market cap, a traditional style index would hold them equally. If the market cap stays the same, so will their weight. However, if you weight on price/book (or more likely a composite of fundamentals), and the fundamentals of one company changes but the market cap stays the same, you would weight towards the more valuey company. As the price of the over-valued company comes back down to earth, you'll be holding less of it because the fundamentals told the index it seemed overvalued.
Also, if you were to compare exposures to the value factor (HML) between a traditional style value fund and a fundamentally indexed one, you might not see any difference (in their average). If you look at rolling Fama-French regressions though, you will see a wider variation for value spreads for the fundamental index. Even Asness who is fond of dissing fundamental indexes is in the literature saying “value spreads… are important indicators of the attractiveness of value over growth.”
There also appears to be differences across the value cycle, and it's been suggested that the value exposure of a fundamental index may decrease before a period of value underperformance.
Finally, there are difference in momentum exposure as well that may be favorable to a fundamental index. I am not completely clear on this because I understand fundamental indexes to have the same problem as a typical value fund but maybe it is a matter of degree.
So time will tell in the returns of live funds I guess. I read what Vanguard said but unless they address how exposure to the value factor varies in time across market cycles, then their point is a little off I think.
So I look a Schwab's FNDA (Russell Fundamental Index -small mid cap), and I see mid-cap growth has a much larger holding than I would see in Vanguard's mid cap (VOE) or small cap funds (VBR). Do I want to avoid growth companies or do I want exposure to the more valuey companies in what might be less valuey industries?
Anyway, if the value premium is mean reverting, then I like the way the Fundamental Index will adjust to hold relatively more valuey companies.
http://www.iinews.com/site/pdfs/JII_Summer_2014_RA.pdf
http://www.russell.com/documents/indexe ... esting.pdf