The Research Affiliates founder helped introduce an alternative to traditional equity indexes that has grown popular with ETF investors.
February 17, 2015
By Robert Stowe England
At first, Fundamental indexation was dismissed as “just another clever repackaging of value investing,” recalls Rob Arnott, the leading light behind the idea. A decade ago the co-founder, chairman and CEO of Research Affiliates and two colleagues at the Newport Beach, California–based investment strategy firm introduced their alternative to traditional equity indexes. The promise: An index that weights each listed company using several metrics of its economic footprint could earn a premium over comparable indexes like the S&P 500 and the Russell 1000, which are based on market capitalization. The metrics for fundamental indexation include book value, earnings, revenue, sales, dividends and total number of employees.
Investors have since flocked to fundamental indexation exchange-traded funds. Licensees of the Research Affiliates Fundamental index (RAFI) methodology now use it to manage $140 billion in assets. Arnott rattles off several providers of RAFI strategies: BlackRock, Charles Schwab Corp., Invesco PowerShares, Pacific Investment Management Co. and State Street Corp. in the U.S.; Legal & General Group in the U.K.; Nomura Holdings in Japan; and Colonial First State’s Realindex Investments in Australia.
In the broader category of smart beta funds — rules-based passive vehicles that reject market-cap weighting — there are $402 billion in assets with 391 exchange-traded products, according to Chicago-based Morningstar, which calls them strategic beta funds. Then there are 33 RAFI strategies to which institutional investors have allocated, reports eVestment, a Marietta, Georgia–based data provider. At least one major public pension plan, the California Public Employees’ Retirement System, runs an in-house fundamental indexation strategy, an effort that began in 2006.
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