Your Edge vs. the Index You Can Actually Buy

Quality investing has genuine academic support, and in our tests gross profitability — Novy-Marx’s (revenue minus cost of goods) over assets, the profitability factor behind Fama-French RMW — was the most credible real edge we found: a positive information coefficient in every regime, t=1.69, theory-backed, and it did not collapse at scale the way option-skew did. But how big the edge looks depends entirely on what you compare it to, and that choice is where a great deal of phantom alpha is born.

How much did the benchmark matter?

Measured against an equal-weight basket of the same stocks, a gross-profitability tilt added about +2.7%/yr (16.2% annual return, Sharpe 0.99, versus the equal-weight index’s 13.5% and 0.78 over 2016–2024). A clean, fundable-looking result. Then we changed the benchmark to the real cap-weighted index — the thing a client could buy in an ETF for a few basis points. The edge shrank to roughly +0.6%/yr at a modest tilt, and went negative as the tilt increased.

Where did the rest of the edge go?

Two places. First, the cap-weighted index had already done much of the work: 2016–2024 cap-weighting concentrated heavily in high-gross-profit mega-cap technology, so the profitability premium was largely harvested by simply holding the index. Beating an equal-weight basket that under-owns those names is easy; beating the cap-weighted index that over-owns them is not.

Second, some of the “edge” was never there. A no-tilt basket appeared to beat the index by +3.2%/yr — impossible for a strategy with no signal, and a direct measure of the survivorship bias leaking through the universe. Once we benchmarked honestly against the investable cap-weighted index and used survivorship-free data, the survivorship distortion (~+3%/yr) plausibly exceeded the true factor edge (~+0.6%/yr). The apparent alpha mostly dissolved.

About this series: every figure comes from a leak-free research harness on US equities — point-in-time index membership, fundamentals keyed to filing date, expanding-window walk-forward, and transaction costs charged. Statistics are gross and in-sample unless noted, and describe published anomalies, not a Yayati product. Standing caveats: roughly a third of true historical index members are unpriced by the naive data source (survivorship); a 2 bps cost assumption is optimistic; fundamentals are post-2009 XBRL.

This article is for educational and informational purposes only and is not investment, tax, or legal advice. It describes findings from an internal research program about publicly documented market anomalies and research methodology; it is not a description of any Yayati product or its results. Research statistics are gross, in-sample illustrations subject to survivorship, data-coverage, transaction-cost, and modeling limitations described in the text, and do not represent actual trading or any client account. Past performance and backtested results are not indicative of future results. Yayati Asset Management is a Registered Investment Adviser. © Yayati Asset Management. VOLT™ and PLASMA™ are trademarks of Yayati.