Arnott: The RAFI Five-Year Scorecard

January 31, 2011

RAFI strategies may play an important role as a low-cost 'core' part of investors' equity portfolios.


When the Fundamental Index® concept was introduced, it was met with fierce attacks. Critics decried its backtested results as data-mining or said the approach was just a repackaged value investment process. Five years after the first RAFI indices went live, the proof is in: The methodology has generated superior performance during a period when value has lagged growth all over the world.

In a relatively short span of time, the Fundamental Index approach has revolutionized passive investing and has served as an important milestone in the evolution of our investment thinking, helping spawn a new field of investing—that of Alternative Beta or Strategy Indices. In this issue we show that live RAFI results support our earlier research and the robustness of the Fundamental Index methodology.

RAFI’s Better Beta

We published our initial research on the Fundamental Index concept in the March/April 2005 issue of the Financial Analysts Journal, showing how the methodology outperformed in U.S. markets during a 43-year span ending December 2004, based on a simulation.1

That initial research was extended by Nomura Securities to cover the 23 developed markets in the FTSE Developed Index.2 The results are summarized in Table 1. Impressively, the Fundamental Index approach generated excess returns over cap weighting in 21 of the 23 developed market applications over a 21-year period. The average outperformance in developed large company markets was 2.7%. With these results in hand, we concluded that an investor could achieve a return of 2–4% over cap-weighted indexes in developed markets, over a complete market cycle.

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Since FTSE launched its FTSE RAFI family of indexes in November 2005, we’ve lived through two bull markets sandwiched around the biggest global bear market since the 1930s. If this isn’t a full market cycle, we are not sure what is. Value stocks won handily in 2006 and the middle quarters of 2009, flanked by years of mostly growth equity outperformance. So how has the Fundamental Index approach fared over this stretch?

Using live results, 19 of 23 countries added value via the Fundamental Index methodology. The average excess return per country has been 2.0%, as shown in Table 2. The FTSE RAFI US 1000 Index produced an excess return of 2.3% per annum, just a bit better than our original study showed.3



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