The Role of Indexing :  RAFI® Fundamental Indexes

Claymore's Fundamental Index® based ETFs offer the advantages of an active management strategy with the focus of passive investing: low costs, lower turnover, transparent rules-based selection, and broad diversification.

How RAFI® is Weighted

Research Affiliates selects and gives index weights to companies in Fundamental Index portfolios based on four key financial measures of a company's size that are indifferent to its stock price and consequently to its market cap or weighting in an index:

  • Totals Sales
  • Total Cash Flow
  • Total Gross Dividends paid
  • Book Equity Value

These measures rely on easily accessible data, and are not intended to be predictive of future size or value. The key is that they minimize the return drag associated with cap-weighted indexes..

By using fundamental factors rather than prices to weight stocks, Fundamental indexing takes advantage of price movements by reducing the index's constituents whose prices have risen relative to other constituents, and increasing holdings in companies whose prices has fallen behind. This is effectively a buy-low, sell-high strategy.

The Difference Is Fundamental

A capitalization-weighted index, such as the S&P/TSX 60 Index, weights its components (or companies included in the index) by the total market value of their outstanding shares. The math is simple: number of shares outstanding X current market price. The impact of each component stock's price change on the index is proportional to its overall market value, not the fundamental value of the stock itself. In other words, the more a stock increases in price, the higher the weighting in the portfolio. In a Fundamental Index® portfolio, on the other hand, stocks are weighted by fundamental factors such as sales, cash flow, dividends, and book value. These factors measure the economic footprint of a company, not its stock price. Breaking the link between stock price and index weighting is critical--it eliminates the return drag built into cap-weighted indexes.

A Better Index for Investing

The Fundamental Index® methodology is based on the theory that markets and prices everyday are not perfectly efficient , and that prices revert to their "fair value" over time. Weighting using fundamentals creates a stable anchor to trade against the market's constantly shifting expectations, fads and bubbles. In fact, this "contra rebalancing" provides a significant source of added value over time.

A Proven Strategy

Research Affiliates® original research found that a Fundamental Index® portfolio outperformed a comparable cap-weighted portfolio of U.S. large company equities by more than 2% annually over the 43 years tested. Active portfolio managers would be ecstatic to obtain such outperformance. Equally important, Fundamental Index® portfolios preserve the original benefits of traditional capitalization-weighted indexes, including broad diversification, economic representation, liquidity, scalability, low turnover, and tax efficiency.

  Average Annual Return
Index Name YTD 1 Year 3 Year* 5 Year*
FTSE RAFI Canada Index -10.61% -3.91% 5.08% 4.12%
S&P/TSX 60 Index -11.57% -4.27% 0.89% 2.14%
Outperformance 0.96% 0.36% 4.19% 1.71%
FTSE RAFI US 1000 Index -10.97% -0.38% 4.76% 0.13%
S&P 500 Index -8.68% 1.14% 1.23% -1.18%
Outperformance -2.29% -1.52% 3.53% 1.31%
FTSE RAFI Developed ex US 1000 Index -16.69% -11.42% 0.53% -1.66%
MSCI EAFE Index -14.80% -8.97% -0.98% -2.58%
Outperformance -1.89% -2.45% 1.51% 0.92%

*Annualized. Source: Research Affiliates LLC.as of 9/30/11.

Equally important, Fundamental Index® portfolios preserve the original benefits of traditional capitalization-weighted indexes, including broad diversification, economic representation, liquidity, scalability, low turnover, and tax efficiency.

 

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