An Advisor Explains Why He Owns PRF

 

In May 2006. The ETF launched in December 2005, so I was an early adopter. When I had the index methodology explained to me, I liked the idea. 

 

PRF is one of the earliest ETFs using an alternative weighting for index construction; it uses sales, cash flow, dividend and book value to calculate the weighting of the holdings in the index. 

 

There was almost a common-sense aspect to the fund I found appealing. Then, looking at the research Rob Arnott had done in constructing the index, I thought it was very intellectually rigorous as well. 

 

I do. Fundamentally weighted indexes complement the market-cap-weighted ones. I may have up to 60% of an asset class in market cap and 40% in alternative weighting. 

 

Yes. Because although the markets are highly efficient, history has shown us that they’re not perfectly efficient. I lived through the tech bubble, I lived through this subprime tsunami, and it seems that at the extremes, the market can become overweighted in overvalued stocks. So an index that takes price out of weighting helps reduce the risk that, when the market hits extremes, you’ll be overweighted in the frothiest sectors. 

 

I obviously was not afraid of a new ETF. For me, if something is systematic, transparent and rules-based, then my faith is in those rules and the sponsor behind them. If you get too much human intervention, then emotion can start to come in.

 

You’ll pay a little more for these alternative weighting schemes. That’s one of the reasons I like to pair them with the more liquid, less expensive market cap.

 

There are advantages to using super-cheap market-cap ETFs, and some advantages to alternatively weighted ones. So why not use both? I don’t think it has to be either/or.

 

It’s not easy for me to devise a scenario. If PowerShares did something really strange as far as its structure, or if it raised the cost or something—but I think I’ll be in this for the long haul. It’s a core investment for at least another generation. When my successor inherits these portfolios, I think PRF will still be in there. 

 

The way to think about it is, if the market-cap index has a flaw, it would be that if there are overvalued stocks, then sometimes that index would overweight overvalued stocks. The key word there is “if.” 

 

It’s how you react to that word “if” that tells you if this index is for you. If you think there are episodes in the market cycle where overvalued stocks arise, then you should probably look more at alternatively weighted indexes to decide which one(s) would be useful as a hedge against that possibility.