Explanation

The correct answer is B. Fundamental weighting.

Let's analyze each of the fund manager's preferences against the three weighting methods:

1. Contrarian effect

• Fundamental weighting: Has a contrarian effect because it weights companies based on fundamental measures (like sales, cash flow, dividends, book value) rather than market price. When a stock becomes overvalued (high price), its market-cap weight increases but its fundamental weight may not change proportionally, creating a contrarian tilt.
• Equal weighting: Also has a contrarian effect because it rebalances regularly, selling winners and buying losers.
• Float-adjusted market cap: Does NOT have a contrarian effect - it's momentum-based (buys more of what's going up).

2. Shares held by controlling shareholders should be included

• Fundamental weighting: Typically includes all shares outstanding, not just the free float.
• Float-adjusted market cap: EXCLUDES shares held by controlling shareholders (uses only free float).
• Equal weighting: Usually uses all shares outstanding.

3. Dividends should be included in the weighting

• Fundamental weighting: Often includes dividends as one of the fundamental factors in weighting.
• Equal weighting: Ignores dividends in weighting.
• Float-adjusted market cap: Ignores dividends in weighting.

4. Weights should not be arbitrarily determined by the index provider

• Fundamental weighting: Uses objective, rules-based fundamental measures.
• Equal weighting: Somewhat arbitrary (why equal weight rather than some other scheme?).
• Float-adjusted market cap: Objective but based on market prices.

Key Distinction:

• Fundamental weighting meets ALL four criteria:

  1. Contrarian effect ✓
  2. Includes controlling shareholders' shares ✓
  3. Includes dividends in weighting ✓
  4. Not arbitrary (rules-based on fundamentals) ✓

• Equal weighting fails on criterion 3 (doesn't include dividends in weighting).

• Float-adjusted market cap fails on criteria 1 (no contrarian effect), 2 (excludes controlling shareholders), and 3 (doesn't include dividends).

Therefore, fundamental weighting is the only option that satisfies all of the fund manager's preferences.