Tag Archives: fundamental indexing

RAFI Wins Patent

Wow. So many great lead sentences that I don’t even know where to start.

Take that, market capitalization!

Take that, John Bogle!

Take that, Wisdomtree.

You get the point.

Research Affiliates, the asset management house that started the ETF Industry’s Index Wars, Wednesday received a U.S. patent on its Fundamental Index Investment Methodology. Vindication is sweet and I’m sure the folks at Research Affiliates poured champagne all over their heads as if they just won the World Series.

The Research Affiliates Fundamental Index, better known as the RAFI, selects and weights securities using four fundamental metrics of company size instead of market capitalization: total cash dividends, free cash flow, total sales and book equity value.

Whether or not this puts to rest who was the first to create an index or strategy based on fundamental metrics, it clearly says who has the rights to this methodology. The question now is does this extend to any index that follows a methodology based on fundamental metrics, or just ones using the same metrics as the RAFI? More important will there be a legal battle between Research Affiliates and its main competitor in the fundmal indexing space, the ETF firm WisdomTree.
Research Affiliates doesn’t manage any ETFs, but rather licenses indexes to ETF and mutual fund providers, its core business is developing and licensing new product ideas.

“So, unlike most asset managers, we have only our ideas to sell; we can protect these ideas as trade secrets or with patents,” said Robert Arnott, chairman and founder of Research Affiliates, in a written statement. “As we want to encourage wide use of these ideas, we favor the latter.”

Fundamental indexing has been a big deal to the ETF and indexing community ever since Arnott and his colleague Jason Hsu examined the concept in a 2005 issue of the Financial Analysts Journal. The basic premise is market-cap indexes overweight overpriced stocks and underweight under priced stocks which is exactly the opposite of what you the investor want to buy. It’s an interesting concept. I will publish I study I did on fundamental indexing later.

According to Research Affiliates’ original work, the historical return drag associated with this structural flaw is typically 2% to 4% per year, globally. Through October 31, Research Affiliates says the FTSI RAFI 1000 Index, which comprises large-cap U.S. equities, outperformed the S&P 500 by 14.39% in 2009, by 1.47% on an annualized basis for the last three years, and by 1.94% annualized since inception of the index. The FTSE RAFI Developed ex US 1000 Index, which comprises large-cap developed foreign market stocks, outperformed the MSCI EAFE Index by 12.71% for 2009, by 3.48% over three years annualized, and 3.18% since inception.

PowerShares is the only place to buy the RAFI in an ETF.

  • PowerShares FTSE RAFI US 1000 Portfolio (PRF). This ETF tracks the FTSI RAFI 1000 Index.
  • PowerShares FTSE RAFI US 1500 Small-Mid Portfolio (PRFZ)
  • PowerShares FTSE RAFI Asia Pacific ex-Japan Portfolio (PAF)
  • PowerShares FTSE RAFI Developed Markets ex-U.S. Portfolio (PXF). This tracks the above mentioned FTSE RAFI Developed ex US 1000 Index.
  • PowerShares FTSE RAFI Developed Markets ex-U.S. Small-MidPortfolio (PDN)
  • PowerShares FTSE RAFI Emerging Markets Portfolio (PXH)
  • PowerShares FTSE RAFI Europe Portfolio (PEF)
  • PowerShares FTSE RAFI Japan Portfolio (PJO)

BGI Launches International Bond Funds; RevenueShares Tries Navellier Strategy

Three new ETFs launched on Friday, two international bond ETFs from Barclays Global Investors (BGI) and an RevenueShares fund based on a strategy from mutual fund maven Louis Navellier.

RevenueShares Investor Services launched the RevenueShares Navellier Overall A-100 Fund (RWV) on the New York Stock Exchange ARCA. Less than a year old, RevenueShares is the most recent entrant in the ETF space for Fundamental Indexing. Proponents of the concept of fundamental indexing believe indexes based on fundamental metrics produce better returns than indexes based on market capitalization, such as the S&P 500. In a dig at WisdomTree, the fundamental house that builds indexes based on dividends, Sean O’Hara, president of RevenueShares, tells ETF Trends, while dividends can be adjusted, revenues are the one variable that can’t be fudged. Well, they can’t be fudged unless the company decides to do a little technique called stuffing the channel. In channel stuffing a company books sales from the future in the current quarter. But, that’s highly frowned upon, so it doesn’t happen much, so I won’t dwell on it.

Anyway, they take that revenues-based index and mix it with a quantitative methodology from Navellier’s firm Navellier & Associates. The strategy seeks to beat the benchmark indexes with what they call alpha generating growth strategies. Alpha is that bit of return that a manager’s skill adds to the fund’s returns. ETF Trends says “The fund is constructed using an 8-factor model to give stocks a letter grade. From there, the top 100 A-rated stocks are included and ranked by revenue annually on Sept. 1, and rebalanced on the first day of each calendar quarter.”

Also on Friday, BGI launched two new ETFs on the Nasdaq Stock Market.

iShares S&P/Citigroup International Treasury Fund (IGOV)
iShares S&P/Citigroup 1-3 Year International Treasury Bond Fund (ISHG)

They both charge and expense ratio of 0.35%. These are the first two iShares ETFs to list on NASDAQ in 2009, compared to eight listings in 2008 and five in 2007. Nasdaq says it’s the most liquid U.S. market for ETFs, capturing 34.8% of all U.S. ETF volume in December.

ETFguide says with only four broadly diversified international bond ETFs (including these two) and one emerging markets bond ETF these are the least populated areas in the U.S. ETF market. With 8.22 years as the average weighted maturity for the bonds, IGOV is the long-term option. ETFguide breaks down IGOV three largest country allocations: Japan (24.95%), Germany (9.28%), and Italy (8.74%). The bonds in the short-term ISHG have an average weighted maturity of 1.87 years and with the largest country allocations in Japan (24.95%), Germany (10.95%), and Italy (7.99%).