Fundamental indices: Difference between revisions
m (table correction (added "value") |
(Replaced link with archival version.) |
||
(31 intermediate revisions by 3 users not shown) | |||
Line 1: | Line 1: | ||
{{Main|Alternative indices}} | |||
'''{{PAGENAME}}''', developed by Research Affiliates <ref>[http://www.researchaffiliates.com/rafi/rafi.htm Research Affiliates RAFI Overview]</ref> and calculated by FTSE, are known as Research Affiliates Fundamental Index (RAFI). RAFI indices are passively managed market cap indices that use a security weighting system that ranks stocks according to four fundamental value factors. | |||
Fundamental indices occupy the '''Passive''' security selection/ '''Fundamental''' security weighting segnent of the [[:Indexing#Index Strategy Boxes | Index Strategy Box]] (Fig.1). | Fundamental indices occupy the '''Passive''' security selection/ '''Fundamental''' security weighting segnent of the [[:Indexing#Index Strategy Boxes | Index Strategy Box]] (Fig.1). | ||
[[File:Fundamental Index Strategy Box.png|thumb|center|250px|caption| Fig.1. Index Strategy Box <ref>[http://www.portfoliosolutions.com/f-18.html Indexing in the 21st Century: Portfolio Solutions Inc.]</ref>]] | [[File:Fundamental Index Strategy Box.png|thumb|center|250px|caption| Fig.1. Index Strategy Box <ref>[https://web.archive.org/web/20111230043641/http://www.portfoliosolutions.com/f-18.html Indexing in the 21st Century: Portfolio Solutions Inc.]</ref>]] | ||
RAFI indices have also been developed for the bond market, and are calculated in conjunction with Ryan ALM, Inc. <ref>[http://www.researchaffiliates.com/rafi/bonds.htm Research Associates: RAFI Bonds] | RAFI indices have also been developed for the bond market, and are calculated in conjunction with Ryan ALM, Inc. <ref>[http://www.researchaffiliates.com/rafi/bonds.htm Research Associates: RAFI Bonds] | ||
Line 50: | Line 49: | ||
*FTSE/JSE RAFI 40 3/16/2007 | *FTSE/JSE RAFI 40 3/16/2007 | ||
*RAFI Emerging Markets 03/19/2007 | *RAFI Emerging Markets 03/19/2007 | ||
*RAFI Developed Markets 08/06/ | *RAFI Developed Markets 08/06/2007 | ||
*RAFI Ex US Mid/Small 1500 08/06/2007 | *RAFI Ex US Mid/Small 1500 08/06/2007 | ||
*RAFI Developed Asia/Pacific Ex Japan Mid/Small 08/06/2007 | *RAFI Developed Asia/Pacific Ex Japan Mid/Small 08/06/2007 | ||
Line 95: | Line 94: | ||
Fundamental Indexing is the subject of [[Fundamental Indices#Debate | considerable debate]] among both [[Fundamental Indices#Academic Papers|investment professionals]] and [[Fundamental Indices#Forum Discussions|individual investors]]. | Fundamental Indexing is the subject of [[Fundamental Indices#Debate | considerable debate]] among both [[Fundamental Indices#Academic Papers|investment professionals]] and [[Fundamental Indices#Forum Discussions|individual investors]]. | ||
===Security | ===Security selection and weighting=== | ||
The construction of a RAFI index begins with the selection of a company universe (for example the FTSE All US All Cap Index, or the FTSE Developed ex US Index) and a screening process that ranks the companies according to four fundamental valuation factors: sales, cash flow, book value, and dividends (see table below). The selection and weighting process is described in detail in the quote box, ''RAFI Index Construction Rules''. | The construction of a RAFI index begins with the selection of a company universe (for example the FTSE All US All Cap Index, or the FTSE Developed ex US Index) and a screening process that ranks the companies according to four fundamental valuation factors: sales, cash flow, book value, and dividends (see table below). The selection and weighting process is described in detail in the quote box, ''RAFI Index Construction Rules''. | ||
Line 112: | Line 111: | ||
|} | |} | ||
===Rebalancing and | ===Rebalancing and turnover=== | ||
In order to preserve proper weighting of companies, fundamental indices are rebalanced once a year. The result is that fundamental indices have higher turnover than do comparable asset class market capitalization indices. In terms of implementation, ETF manager Powershares has managed its RAFI funds with much less turnover than mutual fund manager Schwab. <ref>[http://www.invescopowershares.com/pdf/P-PS-PRO-2.pdf Powershares US RAFI prospecus] <br> [http://www.invescopowershares.com/pdf/P-PS-PRO-8.pdf Powershares International RAFI prospectus]<br>[http://hosted.rightprospectus.com/SF/Fund.aspx?dt=P&cu=808509442 Schwab annual report].</ref> | In order to preserve proper weighting of companies, fundamental indices are rebalanced once a year. The result is that fundamental indices have higher turnover than do comparable asset class market capitalization indices. In terms of implementation, ETF manager Powershares has managed its RAFI funds with much less turnover than mutual fund manager Schwab. <ref>[http://www.invescopowershares.com/pdf/P-PS-PRO-2.pdf Powershares US RAFI prospecus] <br> [http://www.invescopowershares.com/pdf/P-PS-PRO-8.pdf Powershares International RAFI prospectus]<br>[http://hosted.rightprospectus.com/SF/Fund.aspx?dt=P&cu=808509442 Schwab annual report].</ref> | ||
Line 125: | Line 124: | ||
{| class="wikitable sortable" style="text-align:center" width=350px | {| class="wikitable sortable" style="text-align:center" width=350px | ||
|+ RAFI US 1000 Index Returns <ref>[http://sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[ | |+ RAFI US 1000 Index Returns <ref>[http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[US large cap index returns]]</ref> | ||
| align="center" style="background:#f0f0f0;"|'''Year''' | | align="center" style="background:#f0f0f0;"|'''Year''' | ||
| align="center" style="background:#f0f0f0;"|'''RAFI 1000''' | | align="center" style="background:#f0f0f0;"|'''RAFI 1000''' | ||
Line 141: | Line 140: | ||
{| class="wikitable sortable" style="text-align:center" width=350px | {| class="wikitable sortable" style="text-align:center" width=350px | ||
|+ RAFI US 1500 Index Returns <ref>[http://sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[ | |+ RAFI US 1500 Index Returns <ref>[http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[US small cap index returns]]</ref> | ||
| align="center" style="background:#f0f0f0;"|'''Year''' | | align="center" style="background:#f0f0f0;"|'''Year''' | ||
| align="center" style="background:#f0f0f0;"|'''RAFI 1500''' | | align="center" style="background:#f0f0f0;"|'''RAFI 1500''' | ||
Line 155: | Line 154: | ||
{| class="wikitable sortable" style="text-align:center" width=350px | {| class="wikitable sortable" style="text-align:center" width=350px | ||
|+ RAFI Developed Ex-US Index Returns <ref>[http://sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[International Developed Market Index Returns]]</ref> | |+ RAFI Developed Ex-US Index Returns <ref>[http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[International Developed Market Index Returns]]</ref> | ||
| align="center" style="background:#f0f0f0;"|'''Year''' | | align="center" style="background:#f0f0f0;"|'''Year''' | ||
| align="center" style="background:#f0f0f0;"|'''RAFI Dev. Ex-US''' | | align="center" style="background:#f0f0f0;"|'''RAFI Dev. Ex-US''' | ||
Line 171: | Line 170: | ||
{| class="wikitable sortable" style="text-align:center" width=350px | {| class="wikitable sortable" style="text-align:center" width=350px | ||
|+ RAFI Developed Ex-US Mid/Small Index Returns <ref>[http://sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[International Developed Market Index Returns]]</ref> | |+ RAFI Developed Ex-US Mid/Small Index Returns <ref>[http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=S000011995&type=485&dateb=&count=40&scd=filings Data Source:Edgar Prospectus Filings]; [[International Developed Market Index Returns]]</ref> | ||
| align="center" style="background:#f0f0f0;"|'''Year''' | | align="center" style="background:#f0f0f0;"|'''Year''' | ||
| align="center" style="background:#f0f0f0;"|'''RAFI Dev. Ex-US Mid/Small''' | | align="center" style="background:#f0f0f0;"|'''RAFI Dev. Ex-US Mid/Small''' | ||
Line 182: | Line 181: | ||
|} | |} | ||
==Investment | ==Investment options== | ||
RAFI Index funds are available from [http://www.schwab.com/public/ | RAFI Index funds are available from [http://www.schwab.com/public/schwab_oldpublicsite/research_strategies/mutual_funds/funds/fundamental_index_funds Charles Schwab] (mutual funds) and [http://www.invescopowershares.com/products/ Powershares] ([[Exchange Traded Funds | as ETFs]]). In June, 2011, Powershares expanded its lineup of RAFI indices by changing the benchmarks of seven ETFs formerly tied to Intellidex Indices to RAFI fundamental indices, and by offering two new RAFI ETFs. <ref>[http://www.indexuniverse.com/hot-topics/9388-powershares-makes-big-rafi-related-moves-.html PowerShares Makes Big RAFI-Related Moves], indexuniverse.com. (June 16, 2011) </ref> PIMCO offers four institutional enhanced RAFI index funds. | ||
==See also== | ==See also== | ||
*[[:Alternative | *[[:Alternative indices]] | ||
==References== | ==References== | ||
{{Reflist|30em}} | |||
==External | ==External links== | ||
*[http://www.researchaffiliates.com/rafi/rafi.htm Research Affiliates RAFI Overview] | *[http://www.researchaffiliates.com/rafi/rafi.htm Research Affiliates RAFI Overview] | ||
===Fundamental | ===Fundamental index methodologies=== | ||
*[http://www.ftse.com/Indices/FTSE_RAFI_Index_Series/index.jsp FTSE RAFI Index Series] | *[http://www.ftse.com/Indices/FTSE_RAFI_Index_Series/index.jsp FTSE RAFI Index Series] | ||
*[http://www.ftse.com/Indices/FTSE_RAFI_Index_Series/2008Downloads/FTSE_RAFI_Indexes_Methodology_overview.pdf FTSE RAFI Index Series Methodology Overview] | *[http://www.ftse.com/Indices/FTSE_RAFI_Index_Series/2008Downloads/FTSE_RAFI_Indexes_Methodology_overview.pdf FTSE RAFI Index Series Methodology Overview] | ||
===Forum | ===Forum discussions=== | ||
{{Notice| | |||
Comparing ''fundamental'' to traditional ''capitalization weighted ("cap-weighted")'' benchmark index funds is a subject of constant debate. The following forum threads provide insight. | |||
}} | |||
*[http://www.bogleheads.org/forum/viewtopic.php?t=56090 Fundamental Indexing] | *[http://www.bogleheads.org/forum/viewtopic.php?t=56090 Fundamental Indexing] | ||
*[http://www.bogleheads.org/forum/viewtopic.php?t=19447 'Fundamental Indexing' by Arnott] | *[http://www.bogleheads.org/forum/viewtopic.php?t=19447 'Fundamental Indexing' by Arnott] | ||
Line 209: | Line 209: | ||
===Articles=== | ===Articles=== | ||
*[http://www.indexuniverse.com/publications/journalofindexes/joi-articles/2995.html Rob Arnott, Gus Sauter, Jeremy Siegel, ''Fundamental Indexing Smackdown'', JOI, September/October 2007] | |||
*[http://efficientfrontier.com/ef/0adhoc/fi.htm William Bernstein, Fundamental Indexing and the Three-Factor Model, ''Efficient Frontier'', May, 2006] | *[http://efficientfrontier.com/ef/0adhoc/fi.htm William Bernstein, Fundamental Indexing and the Three-Factor Model, ''Efficient Frontier'', May, 2006] | ||
*[http://johncbogle.com/wordpress/wp-content/uploads/2006/08/WSJ%20op-ed.pdf John C. Bogle and Burton G. Malkiel, ''Turn on a Paradigm?'', June 27, 2006] | *[http://johncbogle.com/wordpress/wp-content/uploads/2006/08/WSJ%20op-ed.pdf John C. Bogle and Burton G. Malkiel, ''Turn on a Paradigm?'', June 27, 2006] | ||
*[http://www.investopedia.com/articles/exchangetradedfunds/08/index-debate.asp Rich White, ''Market Cap, Equal Weight And Fundamental Indexing'', Investopedia] | |||
*[http://en.wikipedia.org/wiki/Fundamentally_based_indexes Wikipedia Fundamentally based indexes] | |||
===Bibliography=== | |||
{| border="0" | |||
|| | |||
* Arnott, Robert D., Hsu, Jason C. and Moore, Philip, ''[http://ssrn.com/abstract=604842 Fundamental Indexation]'', Available at SSRN. | |||
* Arnott, Robert D., Hsu, Jason C., Li, Feifei and Shepherd, Shane D., ''[http://ssrn.com/abstract=1263246 Applying Valuation-Indifferent Indexing to Fixed Income]'', (September 4, 2008). Available at SSRN. | |||
* Blitz, David and Swinkels, Laurens A. P., ''[http://ssrn.com/abstract=1184848 Fundamental Indexation: An Active Value Strategy in Disguise]'' (July 1, 2008). Available at SSRN. | |||
* Dopfel, Fred, ''[https://www2.blackrock.com/webcore/litService/search/getDocument.seam?venue=PUB_INS&source=CONTENT&ServiceName=PublicServiceView&ContentID=1111097825 The Arithmetic of Fundamental Indexing]'', Investment Insights, 6.07. June 2007, Volume 10, Issue 3, Barclays Global Investors | |||
* Estrada, Javier, ''[http://ssrn.com/abstract=949162 Fundamental Indexation and International Diversification]'', (December 2006). Available at SSRN. | |||
* Hsu, Jason C. and Campollo, Carmen, ''[http://ssrn.com/abstract=843384 An Examination of Fundamental Indexation]'',(November 2005). Available at SSRN. | |||
* Kaplan, Paul D.,''[http://www.top1000funds.com/attachments/202_Why%20Fundamental%20Indexation%20%20Might%E2%80%94or%20Might%20Not%E2%80%94Work.pdf Why Fundamental Indexation Might—or Might Not—Work]'' FAJ, Volume 64, No.1, 2008 CFA Institute | |||
* Perold, Andre, F. ''[http://www.inbest.co.il/Images/flawedindex.pdf Fundamentally Flawed Indexing]'' FAJ, Volume 63, No.6, 2007 CFA Institute | |||
* Treynor, Jack, ''[http://www.researchaffiliates.com/ideas/pdf/indifferentIndexing.pdf Why Market-Valuation-Indifferent Indexing Works]'', Financial Analysts Journal Volume 61 • Number 5 ©2005, CFA Institute | |||
|} | |||
= | {{Alternative indices|state=collapsed}} | ||
[[Category:Indexing]] | [[Category:Indexing]] |
Latest revision as of 00:43, 21 April 2016
Fundamental indices, developed by Research Affiliates [1] and calculated by FTSE, are known as Research Affiliates Fundamental Index (RAFI). RAFI indices are passively managed market cap indices that use a security weighting system that ranks stocks according to four fundamental value factors. Fundamental indices occupy the Passive security selection/ Fundamental security weighting segnent of the Index Strategy Box (Fig.1).
RAFI indices have also been developed for the bond market, and are calculated in conjunction with Ryan ALM, Inc. [3]
History
Fundamental indexing was developed by Robert Arnott and associates at Research Affiliates, who developed the index security selection and weighting methodologies and researched historical back-tested performance. In 2005, they partnered with index provider FTSE to begin calculating a growing suite of RAFI indices, both for US and international stock markets. The following table shows the historical introduction of RAFI indices.
Year | US Indices | International Indices |
---|---|---|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
| |
2009 |
|
Research Affiliates was granted a patent on the RAFI methodology on November 18, 2009 [5]
In 2010 Research Affiliates laid the methodology groundwork for constructing fundamental bond indices in a paper published in the Journal of Portfolio Management. [6]. On February 10, 2010 Research Affiliates partnered with Ryan ALM, Inc. to construct and calculate a series of RAFI US bond indices. [7]
Characteristics
RAFI Index Construction Rules
"1. The process starts with the selection of the company universes. For the FTSE RAFI US 1000 Index, the constituents of the FTSE US All Cap Index are used, and for the FTSE RAFI Developed ex US 1000 Index the constituents of the FTSE Developed ex US Index are used. The only difference between the two universes is that the FTSE US All Cap Index includes large, medium and small cap companies whereas the FTSE Developed ex US Index consists of only large and mid cap companies. Country indexes fall out of the FTSE RAFI Developed ex US 1000 Index. 2. The universe companies are each ranked by each of the following four fundamental measures of company size: book value, cash flow, sales, and dividends. The percentage weight that each company represents of the total value of each fundamental measure is calculated. Trailing five-year averaged data is used to minimize the substantial volatility in the index factors that would result from using year-to-year data. The five-year averaging also reduces index rebalancing turnover. 3. A composite fundamental value is given to each company by taking the average weighting of each fundamental measure. If a company has a zero dividend percentage the average of the other three metrics are taken. The company’s RAFI fundamental value is defined as 10,000,000 times the composite weight. 4. The companies are then ranked in descending order of their RAFI fundamental values. The top 1000 companies derived from the FTSE US All Cap Index then form the constituents of the FTSE RAFI US 1000 Index. Similarly, the top 1000 companies derived from the FTSE Developed ex US Index then form the constituents of the FTSE RAFI Developed ex US Index. 5. The weights in the indexes are then set proportional to their fundamental values. The weighting factor used in the index calculation is derived by dividing the investable RAFI fundamental value of each company by its free-float adjusted market capitalization. If there are fewer than five years of data available, the average of the years of data that are available are taken. It can be shown that although the results are not materially different from those of their trailing five-year counterparts, portfolio turnover is higher. 6.When converting from company level to stock level factors, the fundamental value is calculated at a company rather than a stock level. If a company has two or more lines of stocks in the relevant index, the company’s fundamental value is allocated between these lines of stock in proportion to the free-float adjusted market capitalizations at the date of the rebalancing." | |
-- FTSE RAFI Index Series Methodology Overview |
Fundamental Indexing is the subject of considerable debate among both investment professionals and individual investors.
Security selection and weighting
The construction of a RAFI index begins with the selection of a company universe (for example the FTSE All US All Cap Index, or the FTSE Developed ex US Index) and a screening process that ranks the companies according to four fundamental valuation factors: sales, cash flow, book value, and dividends (see table below). The selection and weighting process is described in detail in the quote box, RAFI Index Construction Rules.
Fundamental Indexing Weighting Factors [8] |
---|
|
Rebalancing and turnover
In order to preserve proper weighting of companies, fundamental indices are rebalanced once a year. The result is that fundamental indices have higher turnover than do comparable asset class market capitalization indices. In terms of implementation, ETF manager Powershares has managed its RAFI funds with much less turnover than mutual fund manager Schwab. [9]
Performance
Debate
Returns
The following tables provide investment returns for two broad-based US RAFI indices that have index tracking funds. Given the value tilt of the RAFI index construction, the return series of comparable Russell market and value indexes is provided for comparison.
Year | RAFI 1000 | Russell 1000 | Russell 1000 Value |
2009 | +41.98% | +28.43% | +19.69% |
2008 | −39.99% | −37.60% | −36.85% |
2007 | +3.05% | +5.77% | −0.17% |
2006 | +19.68% | +15.46% | +22.25% |
Year | RAFI 1500 | Russell 2000 | Russell 2000 Value |
2009 | +55.74% | +27.17% | +20.58% |
2008 | −38.28% | −33.79% | −28.92% |
The following tables provide investment returns for two broad-based International RAFI indices that have index tracking funds. Given the value tilt of the RAFI index construction, the return series of comparable Russell market and value indexes is provided for comparison.
Year | RAFI Dev. Ex-US | Russell Dev. Ex-US | Russell Dev. Ex-US Value |
2009 | +44.05% | +37.47% | +35.68% |
2008 | −44.19% | −42.70% | |
2007 | +12.84% | +8.75% | |
2006 | +25.92% | +29.35% |
Year | RAFI Dev. Ex-US Mid/Small | Russell Dev. Ex-US Small | Russell Ex-US Small Value |
2009 | +55.74% | +47.37% | +39.54% |
2008 | −47.20% | −41.90% |
Investment options
RAFI Index funds are available from Charles Schwab (mutual funds) and Powershares ( as ETFs). In June, 2011, Powershares expanded its lineup of RAFI indices by changing the benchmarks of seven ETFs formerly tied to Intellidex Indices to RAFI fundamental indices, and by offering two new RAFI ETFs. [14] PIMCO offers four institutional enhanced RAFI index funds.
See also
References
- ↑ Research Affiliates RAFI Overview
- ↑ Indexing in the 21st Century: Portfolio Solutions Inc.
- ↑ Research Associates: RAFI Bonds
- ↑ FTSE RAFI Index Series Factsheets
- ↑ Arnott and Co. Land a Patent 11/18/2009
- ↑ Valuation-Indifferent Weighting for Bonds, JFP, Spring 2010
- ↑ New Indexes Extend Fundamental Index® Methodology into Fixed Income
- ↑ FTSE RAFI Index Series Methodology Overview
- ↑ Powershares US RAFI prospecus
Powershares International RAFI prospectus
Schwab annual report. - ↑ Data Source:Edgar Prospectus Filings; US large cap index returns
- ↑ Data Source:Edgar Prospectus Filings; US small cap index returns
- ↑ Data Source:Edgar Prospectus Filings; International Developed Market Index Returns
- ↑ Data Source:Edgar Prospectus Filings; International Developed Market Index Returns
- ↑ PowerShares Makes Big RAFI-Related Moves, indexuniverse.com. (June 16, 2011)
External links
Fundamental index methodologies
Forum discussions
Comparing fundamental to traditional capitalization weighted ("cap-weighted") benchmark index funds is a subject of constant debate. The following forum threads provide insight. |
- Fundamental Indexing
- 'Fundamental Indexing' by Arnott
- Fundamentalists at the Gates: The Trouble With Cap-Weighted
- Is Fundamental Indexing superior to Cap Weighted indexing?
Please ask in the forum if you are unsure about investing in a product.
Articles
- Rob Arnott, Gus Sauter, Jeremy Siegel, Fundamental Indexing Smackdown, JOI, September/October 2007
- William Bernstein, Fundamental Indexing and the Three-Factor Model, Efficient Frontier, May, 2006
- John C. Bogle and Burton G. Malkiel, Turn on a Paradigm?, June 27, 2006
- Rich White, Market Cap, Equal Weight And Fundamental Indexing, Investopedia
- Wikipedia Fundamentally based indexes
Bibliography
|