Research Affiliates, Rob Arnott’s fundamental indexing firm, filed a patent infringement lawsuit against WisdomTree Investments in federal court in Los Angeles, making real what some in the ETF industry have suspected was brewing for some time.
Many had suspected a legal showdown was in the cards, as both firms are behind exchange-traded funds using indexes that screen securities for specific properties that are designed to enhance investment returns. Arnott’s firm is widely recognized in the ETF industry as the pioneer of what he calls “fundamental indexing,” though it remains to be seen whether his Newport Beach, Calif.-based firm will prevail in the suit it launched.
The lawsuit, filed in the U.S. District Court for the Central District of California, alleges that WisdomTree developed financial products using proprietary information that Research Affiliates already had patented, Arnott’s firm said in a press release. Also named in the lawsuit were Mellon Capital Management Corp., and WisdomTree’s exchange-traded fund distributor, ALPS Distributors.
“Research Affiliates has always been a leading innovator of financial products, and we have protected our intellectual property with patents,” Arnott, the chairman and chief executive officer of Research Affiliates, said in the press release. “Our main focus is product quality and performance, but we will protect our intellectual property and the interests of our business partners when our patents are infringed.”
Research Affiliates’ system screens companies for four different qualities before they can be included in a so-called RAFI index. Those parameters are: book value, cash flow, sales and dividends.
The dividend screen may have an outsized importance in the suit, as WisdomTree’s take on fundamental indexing also involves screening companies for their histories of paying dividends. WisdomTree indexes also screens for earnings.
Officials at New York-based WisdomTree weren’t immediately available to comment.
Research Affiliates is strictly an indexing firm, licensing its benchmarks to fund sponsors, while WisdomTree is both an indexing firm and an ETF sponsor. It is one of the rare companies in the U.S. ETF industry that creates and owns indexes that underlie its own funds.
At issue in the lawsuit are the following patents:
- U.S. Patent No. 7,747,502 entitled “Using Accounting Data Based Indexing to Create a Portfolio of Assets”
- U.S. Patent No. 7,792,719 entitled “Valuation Indifferent Non-Capitalization Weighted Index and Portfolio”
- U.S. Patent No. 8,005,740 entitled “Using Accounting Data Based Indexing to Create a Portfolio of Financial Objects”
The Story Of PRF
One of Research Affiliates’ bigger clients is Wheaton, Ill.-based Invesco PowerShares, which has 17 ETFs linked to RAFI indexes that together have $3.17 billion in assets. PowerShares listed the first RAFI-based ETF a bit more than five years ago.
Early this year, PowerShares and Research Affiliates trumpeted the returns of that fund, the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), saying the fundamentally indexed large-cap fund had five-year returns that were almost twice those of the S&P 500 Index.
They said PRF returned 23.1 percent in the period, including reinvested dividends, compared with 11.99 percent for the S&P 500 and 13.81 percent for the Russell 1000 Index of large-cap companies.
WisdomTree, which employs Wharton economics professor Jeremy Siegel as a senior consultant, had total ETF assets of almost $12 billion as of Dec. 1, according to data compiled by IndexUniverse.
It has a number of successful funds, many that screen securities for dividends. One such fund that has gotten good traction recently is the WisdomTree Emerging Markets Equity Income Fund (NYSEArca: DEM). DEM, which launched in July 2007, now has almost $2 billion in assets.
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