A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

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A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by nisiprius » Thu Sep 27, 2018 7:12 am

This was sparked by the thread Research Affiliates: Alternative Risk Premia. My real topic here is: how much conviction should we have in data and strategy presented by directly interested parties (including Vanguard and John C. Bogle, of course)?

Research Affiliates is advocating a strategy they call "Systematic Alternative Risk Premia (SARP)."

Now, big fund companies often offer and promote inconsistent strategies--Vanguard does, too--but I will still ask "will the 'real' Research Affiliates strategy please stand up?"

Because ten years ago, they were all about "fundamental indexing," there was buzz about it in the financial media and in the forum. They weren't the only "fundamental indexers" either, the concept was also supported by WisdomTree and by Fidelity's "enhanced index funds." The very phrase "fundamental indexing" has pretty well quietly faded out, I think. But please note just how much reputation was staked on it. This--

Image

--isn't just an etf.com article, it's a whole book. Written by the principal of Research Affiliates, Rob Arnott. With an introduction by Harry Markowitz, the Nobelist who founded modern portfolio theory. What was claimed? No, I haven't read the book (and won't pay $15 to buy it), but according to Dale Maley's review in this forum,
Arnott claims his fundamental index historically gives a 2% improvement in return compared to conventional cap-weighted indexes [page 263 from 1962-2007 with S&P 500 with a return of 10.3% and sigma of 14.6%.........and his RAFI U.S. Large with a 12.3% return and sigma of 14.4%].
From the jacket blurb as quote on the Amazon website:
In just over three years, the idea has attracted over $20 billion of investment capital from some of the largest and most sophisticated institutional investors in the world... this new twist on indexing can overcome the structural return drag created by traditional capitalization-based indexing strategies—which systematically overweight overpriced securities and underweight underpriced securities... In the years ahead, the Fundamental Index approach will become an important part of the indexing community and an essential alternative for those who are disappointed with the hollow promises of active management and frustrated with the market bubbles that traditional index funds pull us into.
Schwab introduced an index fund tracking the RAFI Fundamental US Large-Cap Index on 3/31/2007, thus constituting an almost perfect "forward" test of Arnott's 4/25/2008 book.

The results to date. "Portfolio" 1 (blue) is 100% SFLNX.
Source
Image
The fundamental index fund fell a bit short of "2% improvement." In fact, the S&P 500 index fund, VFIAX, beat it by every measure, although I wouldn't object to calling it "a tie." The plain old index fund had higher return, lower volatility/risk as measured by standard deviation, lower drawdown in 2008-2009, and higher risk-adjusted return as measured by Sharpe and Sortino ratios.

The comment about "market bubbles that traditional index funds pull us into" seems vitiated by the greater drawdown experienced by the RAFI fund in 2008-2009. Now, I don't know what the unbiased thing to say about performance from the bottom until now. You can say "...but it has outperformed the S&P 500 index fund for ten years," which is probably why it has earned a five-star Morningstar rating, or you can say "it is pulling us into a market bubble just the same way as the traditional index fund."

In any case, it dropped further and then climbed further than the S&P 500 fund, thus behaving in a slightly riskier way, such is not what fundamental indexing was supposed to do.

You can also say that (unlike, let's say, 130/30 funds or allocations to "commodities" in the form of CCFs), investing in this fund didn't do any harm. But it seems fair to say that "fundamental indexing" came with first-rate credentials, a plausible story, impressive backtesting... and has fallen far short of the expectations set by its promoters.

If, within the next few years, the S&P falls -50% and SFLNX falls much less than that, then I'll try to remember to revisit this thread and post a headpalm emoticon.
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by asif408 » Thu Sep 27, 2018 7:54 am

nisiprius wrote:
Thu Sep 27, 2018 7:12 am
In any case, it dropped further and then climbed further than the S&P 500 fund, thus behaving in a slightly riskier way, such is not what fundamental indexing was supposed to do.
I don't claim to be an expert on how the fundamental indexes are advertised, but I've heard Arnott say this is exactly how it works. His claim was something to the effect of that it loses a little more on the way down, but makes it back up and more on the upturn, because the fund tilts more towards value the more value underperforms relative to growth.
nisiprius wrote:
Thu Sep 27, 2018 7:12 am
You can also say that (unlike, let's say, 130/30 funds or allocations to "commodities" in the form of CCFs), investing in this fund didn't do any harm. But it seems fair to say that "fundamental indexing" came with first-rate credentials, a plausible story, impressive backtesting... and has fallen far short of the expectations set by its promoters.

If, within the next few years, the S&P falls -50% and SFLNX falls much less than that, then I'll try to remember to revisit this thread and post a headpalm emoticon.
I agree with your first point in that, although it appears fundamental indexing hasn't necessarily helped returns, it also doesn't appear to hurt much, either, so there appear to be worse things you could do with your money. Plus the expenses aren't much more, at least compared to other types of alternatives you mentioned.

The other claim I've heard Arnott make is that the last 10 years or so growth has outperformed value significantly, yet the fundamental index hasn't underperformed the index appreciably (or, as you say, it wouldn't be unreasonable to call it a tie). His claim is something to the effect of the outperformance will surface during times value beats growth. Since value has been in a decade long bear market relative to growth, you wouldn't necessarily expect to have seen the outperformance over the last decade. Of course, it remains to be seen if this occurs, only time will tell.
Last edited by asif408 on Thu Sep 27, 2018 9:10 am, edited 1 time in total.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by typical.investor » Thu Sep 27, 2018 8:20 am

nisiprius wrote:
Thu Sep 27, 2018 7:12 am
The fundamental index fund fell a bit short of "2% improvement." In fact, the S&P 500 index fund, VFIAX, beat it by every measure, although I wouldn't object to calling it "a tie." The plain old index fund had higher return, lower volatility/risk as measured by standard deviation, lower drawdown in 2008-2009, and higher risk-adjusted return as measured by Sharpe and Sortino ratios.
I do use fundamental indexes and am not displeased. They do have more volatility but I have always accepted that value investing involved more risk.

In any case, let's compare growth and value over that timeframe.

2007 - 2018

VIGRX 10.38% CAGR 0.69 Sharp Ratio 14.96% Stdev [Vanguard Growth Index Investor]
VIVAX 6.90% CAGR 0.48 Sharp Ratio 14.82% Stdev [Vanguard Value Index Inv]
VFINX 8.48% CAGR 0.59 Sharp Ratio 14.43% Stdev [Vanguard 500 Index Investor]

I personally wouldn't expect a fundamental index to outperform during a time when growth stocks did so much better. Perhaps that's how they were sold and yes I agree that's dubious marketing.

The marketing on the Alternative Risk Premia fund seems dubious to me too. Adding in emerging bonds (with the dollar being so strong) or emerging value surely will boost your expected returns today. So comparing returns with those assets, especially leveraged ones look promising. But as they note, the assumptions made about the correlations may not hold and things may not turn out as expected.

Anyway, small cap international shows the fundamental index has better returns (+1.78%CAGR), lower Stdev and higher sharp ratio. https://www.portfoliovisualizer.com/bac ... ion2_2=100

International Dev was about 0.8% better CAGR with a higher Stdev and similar sharp ratio. https://www.portfoliovisualizer.com/bac ... tion3_1=13

So I conclude slightly better returns with more volatility. The real risk isn't the volatility though. The risk was 2008 when the fundamental indexes rebalanced into cheap finance stocks. Or more recently when they went into energy after a big drop. Both times paid off (and both times were much heavier than standard value funds), but there may come a day when the risk shows up for real and the holdings don't recover in your holding period. Small cap international has done well, but may be too heavy in Japanese equities (now 37%) for some people's comfort level.
Last edited by typical.investor on Thu Sep 27, 2018 8:38 am, edited 1 time in total.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by jeffyscott » Thu Sep 27, 2018 8:32 am

asif408 wrote:
Thu Sep 27, 2018 7:54 am
The other claim I've heard Arnott make is that the last 10 years or so value has outperformed growth significantly, yet the fundamental index hasn't underperformed the index appreciably (or, as you say, it wouldn't be unreasonable to call it a tie). His claim is something to the effect of the outperformance will surface during times value beats growth. Since value has been in a decade long bear market relative to growth, you wouldn't necessarily expect to have seen the outperformance over the last decade. Of course, it remains to be seen if this occurs, only time will tell.
Of course you meant the opposite, that growth has outperformed...

Related to your point, I think he has/had claimed that fundamental indexing would about keep pace with cap weighted index in a growth market just as it has. Then as you say, the outperformance shows up when value leads.

Also as of May 2017, Schwab cut the fund's fee to 0.25% from 0.35%. Adding 0.1% to the return would close the gap some more.
press on, regardless - John C. Bogle

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by mojo88 » Thu Sep 27, 2018 8:33 am

Just to add some more context to the discussion. It's impressive the fundamental US large cap index has kept up with the S&P 500, given the fact the Fundamental index significantly underweights the technology sector due to their high valuations. The Fundamental index overweighted financials after the 2008 collapse which paid off. Now the fundamental index has placed an overweight on the energy sector. Rob Arnott believes technology stocks are in bubble territory, if he's right his index may significantly outperform a cap weighted index in the coming years. If he's wrong, the performance gap will widen.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by asif408 » Thu Sep 27, 2018 9:10 am

jeffyscott wrote:
Thu Sep 27, 2018 8:32 am
Of course you meant the opposite, that growth has outperformed...
Yes, typo on my part, thanks! I've corrected it above.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by jeffyscott » Thu Sep 27, 2018 9:34 am

mojo88 wrote:
Thu Sep 27, 2018 8:33 am
Just to add some more context to the discussion. It's impressive the fundamental US large cap index has kept up with the S&P 500, given the fact the Fundamental index significantly underweights the technology sector due to their high valuations.
At least in the current portfolio stats on M*, it's at only about 5% Tech, compared to 23% for S&P 500. Meanwhile even the Value Index is at 15% Tech. If you combine Tech and communication services it's 11% vs. 27% (and 19% for Value Index).

It is interesting to see the difference in how it does this, with the FAANG stocks, compared to the value index. Value index underweights Tech, but does so by excluding FAANG stocks completely (and meanwhile loading up on Microsoft). Fundamental still has Apple as top holding and not much of an underweight at about 4% vs. 4.5% for the S&P 500. Fundamental is drastically underweight Google, Amazon, Facebook (and presumably Netflix) compared to the S&P 500, but does not completely exclude them.
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by Theoretical » Thu Sep 27, 2018 9:41 am

mojo88 wrote:
Thu Sep 27, 2018 8:33 am
Just to add some more context to the discussion. It's impressive the fundamental US large cap index has kept up with the S&P 500, given the fact the Fundamental index significantly underweights the technology sector due to their high valuations. The Fundamental index overweighted financials after the 2008 collapse which paid off. Now the fundamental index has placed an overweight on the energy sector. Rob Arnott believes technology stocks are in bubble territory, if he's right his index may significantly outperform a cap weighted index in the coming years. If he's wrong, the performance gap will widen.
I think this is an under emphasized point, given just how strongly the FAANGs have pushed performance

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by typical.investor » Thu Sep 27, 2018 9:53 am

jeffyscott wrote:
Thu Sep 27, 2018 9:34 am
mojo88 wrote:
Thu Sep 27, 2018 8:33 am
Just to add some more context to the discussion. It's impressive the fundamental US large cap index has kept up with the S&P 500, given the fact the Fundamental index significantly underweights the technology sector due to their high valuations.
At least in the current portfolio stats on M*, it's at only about 5% Tech, compared to 23% for S&P 500. Meanwhile even the Value Index is at 15% Tech. If you combine Tech and communication services it's 11% vs. 27% (and 19% for Value Index).
Are you sure? M* shows me 16% (fundamental index large cap) vs. 23% (S&P500) vs 12% (large value index).

http://portfolios.morningstar.com/fund/summary?t=SFLNX
http://portfolios.morningstar.com/fund/summary?t=fndx

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by jeffyscott » Thu Sep 27, 2018 11:27 am

typical.investor wrote:
Thu Sep 27, 2018 9:53 am
jeffyscott wrote:
Thu Sep 27, 2018 9:34 am
mojo88 wrote:
Thu Sep 27, 2018 8:33 am
Just to add some more context to the discussion. It's impressive the fundamental US large cap index has kept up with the S&P 500, given the fact the Fundamental index significantly underweights the technology sector due to their high valuations.
At least in the current portfolio stats on M*, it's at only about 5% Tech, compared to 23% for S&P 500. Meanwhile even the Value Index is at 15% Tech. If you combine Tech and communication services it's 11% vs. 27% (and 19% for Value Index).
Are you sure? M* shows me 16% (fundamental index large cap) vs. 23% (S&P500) vs 12% (large value index).

http://portfolios.morningstar.com/fund/summary?t=SFLNX
http://portfolios.morningstar.com/fund/summary?t=fndx
Thanks, for the correction. That makes more sense.

It seems I was on the SFNNX (fundamental foreign large cap) page when I looked at that :oops: .

But value index (VIVAX/VVIAX) is 15%+ tech.
press on, regardless - John C. Bogle

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by randomguy » Thu Sep 27, 2018 1:59 pm

jeffyscott wrote:
Thu Sep 27, 2018 8:32 am
asif408 wrote:
Thu Sep 27, 2018 7:54 am
The other claim I've heard Arnott make is that the last 10 years or so value has outperformed growth significantly, yet the fundamental index hasn't underperformed the index appreciably (or, as you say, it wouldn't be unreasonable to call it a tie). His claim is something to the effect of the outperformance will surface during times value beats growth. Since value has been in a decade long bear market relative to growth, you wouldn't necessarily expect to have seen the outperformance over the last decade. Of course, it remains to be seen if this occurs, only time will tell.
Of course you meant the opposite, that growth has outperformed...

Related to your point, I think he has/had claimed that fundamental indexing would about keep pace with cap weighted index in a growth market just as it has. Then as you say, the outperformance shows up when value leads.

Also as of May 2017, Schwab cut the fund's fee to 0.25% from 0.35%. Adding 0.1% to the return would close the gap some more.

So the fund has done exactly what was promised. Compare to the vanguard's value fund that trailed the S&P 500 by 1.7%. What would be interesting to see is how many outperformance periods there are and how often they happen. Alternating 10 years of breakeven and 10 years of outperformance is something I can invest in. 90 years of break even and 10 years of drastic outperformance isn't as remotely useful as an investing strategy.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by Daendrew » Thu Sep 27, 2018 4:12 pm

I have concerns that tech may be irrationally too high. Should I split new contributions 50/50 to a vanilla index and Fundamental Index? Or simply switch to Fundamental Indexing for a while until the market falls again?

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by typical.investor » Thu Sep 27, 2018 5:15 pm

Daendrew wrote:
Thu Sep 27, 2018 4:12 pm
I have concerns that tech may be irrationally too high. Should I split new contributions 50/50 to a vanilla index and Fundamental Index? Or simply switch to Fundamental Indexing for a while until the market falls again?
It's your AA and you have to do what you are comfortable with and will maintain. So I personally would decide an (overall) allocation that I am comfortable keeping long term and make new contributions with that in mind.

There's no reason why value can't go on to underperform for the next 5 years (even if tech is irrationally high now). You don't want to take a position with all new contributions and then get out after being disappointed which as we know value makes people for stretches.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by asset_chaos » Fri Sep 28, 2018 2:43 am

typical.investor wrote:
Thu Sep 27, 2018 8:20 am
I personally wouldn't expect a fundamental index to outperform during a time when growth stocks did so much better. Perhaps that's how they were sold and yes I agree that's dubious marketing.
Maybe I misremember, but I thought Arnott vigorously claimed that fundamental indexing was somehow different from value tilting. Or maybe he claimed that for a while then stopped commenting on the topic. After all, if it's just loading on value, there's nothing terribly remarkable or novel about that, and there are possibly lower cost or better investment vehicles to use to load on value than fundamental indexing. For what it's worth portfoliovisualizer readily affirms that SFLNX has been a large value fund.
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by asif408 » Fri Sep 28, 2018 6:16 am

asset_chaos wrote:
Fri Sep 28, 2018 2:43 am
typical.investor wrote:
Thu Sep 27, 2018 8:20 am
I personally wouldn't expect a fundamental index to outperform during a time when growth stocks did so much better. Perhaps that's how they were sold and yes I agree that's dubious marketing.
Maybe I misremember, but I thought Arnott vigorously claimed that fundamental indexing was somehow different from value tilting. Or maybe he claimed that for a while then stopped commenting on the topic. After all, if it's just loading on value, there's nothing terribly remarkable or novel about that, and there are possibly lower cost or better investment vehicles to use to load on value than fundamental indexing. For what it's worth portfoliovisualizer readily affirms that SFLNX has been a large value fund.
What I've heard him say is that the value tilt shifts based on the performance of value relative to growth. So when value has been doing well the value tilt is smaller and when value has been underperforming the value tilt is larger.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by nisiprius » Fri Sep 28, 2018 6:29 am

asset_chaos wrote:
Fri Sep 28, 2018 2:43 am
typical.investor wrote:
Thu Sep 27, 2018 8:20 am
I personally wouldn't expect a fundamental index to outperform during a time when growth stocks did so much better. Perhaps that's how they were sold and yes I agree that's dubious marketing.
Maybe I misremember, but I thought Arnott vigorously claimed that fundamental indexing was somehow different from value tilting. Or maybe he claimed that for a while then stopped commenting on the topic. After all, if it's just loading on value, there's nothing terribly remarkable or novel about that, and there are possibly lower cost or better investment vehicles to use to load on value than fundamental indexing. For what it's worth portfoliovisualizer readily affirms that SFLNX has been a large value fund.
1) As I understand it, some people are admiring SFLNX for failing to underperform the S&P 500 index.

2) The Research Affiliates website seems quite clear: RAFI™ Strategies
RAFI™ strategies aim to generate excess returns versus the market benchmark through a systematic, contrarian rebalancing approach.
Their commentary here begins:
The RAFI Fundamental US Index underperformed the Russell 1000 Index by 154 bps...
and doesn't mention other indexes. Although it's not stated explicitly there, I take it that the Russell 1000 Index is "the" market benchmark, relative to which the RAFI Fundamental US Index "aims to generate excess returns."

What was "promised," or at least explicitly stated as an "aim," was not beating a value index. The aim is "excess returns via the market benchmark." I don't think a value index is "the market benchmark." RAFI is supposed to beat the market, period.
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by nisiprius » Fri Sep 28, 2018 6:57 am

asset_chaos wrote:
Fri Sep 28, 2018 2:43 am
...Maybe I misremember, but I thought Arnott vigorously claimed that fundamental indexing was somehow different from value tilting. Or maybe he claimed that for a while then stopped commenting on the topic. After all, if it's just loading on value, there's nothing terribly remarkable or novel about that, and there are possibly lower cost or better investment vehicles to use to load on value than fundamental indexing....
In 2011, Arnott described fundamental indexing as "a revolution." That kind of rhetoric was, in fact, in the air a decade ago. Snippets from an interview:
Arnott: The RAFI revolution I think is well under way.... What was a radical idea back in 2005 is becoming very well accepted and is part of a much larger movement.... the fundamental index revolution is gaining enormous traction.

....Ludwig: Is it fair to characterize you as one of the early adopters?

Arnott: One might fairly say I am the inventor, because the patent and trademark office gave us patents on it....
Arnott: ...One group says this is nothing but value. And on one level, they’re right. Viewed in any snapshot in time, all it is is a value tilt. But it’s a dynamic value tilt. And it’s the dynamic element that leads to the sustained, long-term value-add much more so than just the value tilt itself.
So:
  • Arnott called it "revolutionary."
  • Arnott said it that it leads to "much more [long-term value-add] than just the value tilt itself."
  • The RA website says that it "RAFI™ strategies aim to generate excess returns versus the market benchmark," and "the" market benchmark for the RAFI Fundamental US Index is the Russell 1000 index (not the Russell 1000 Value index).
Last edited by nisiprius on Fri Sep 28, 2018 7:04 am, edited 1 time in total.
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by nisiprius » Fri Sep 28, 2018 6:59 am

An interviewer talking to Arnott in 2001 wrote:ProShares is now live with a fundamental long-short strategy. It’s five weeks old and it’s up over 5 percent already. That’s kind of cool for a dollar-neutral absolute-return strategy.

Ludwig: I’ve heard people talk about that as being like the nail in the coffin for cap weighting. They say if you’re able to demonstrate lasting success with a fundamentally weighted long-short strategy, the argument with the cap-weighting crowd will effectively be over. Or would you say the argument is already over?

Arnott: In my view the argument is over.
(In Sgt. Ritzik's voice, for those who know what I'm talking about): Ooh! Ooh!

I've never heard of this one before. I'm stating right now that I'm going to look it up, not knowing yet how it did, and post the results, whatever they turn out to have been.

Source
Blue: RALS, the ProShares RAFI® Long/Short--the ProShares fund Arnott mentions, using the strategy that will be "the nail in the coffin for cap-weighting."
Orange: Morningstar's category average for market neutral funds.
Green: Vanguard Total Bond.

Image

So, if only you'd invested $10,000 into the RALS, the ProShares RAFI® Long/Short ETF at inception, why, just think--you'd have $9,798.39 today. If you'd invested on the day of Arnott's interview, when it "was up 5% already," you'd have even less. Notice that it significantly underperformed the market neutral category average, so I hope I will not be told "it did what it was supposed to do; this is just what you'd expect in a period in which market neutral funds sucked."
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by vineviz » Fri Sep 28, 2018 7:14 am

What was "promised," or at least explicitly stated as an "aim," was not beating a value index. The aim is "excess returns via the market benchmark." I don't think a value index is "the market benchmark." RAFI is supposed to beat the market, period.
[/quote]

You know as well as anyone that investment management companies never "promise" future performance.

In fact, Schwab has taken a fairly consistent tone on this.
A fundamental approach has been shown to add value over long time periods and across various market cycles.
The Schwab Fundamental Index products offer the potential for outperformance relative to market cap index products over time while retaining many of the benefits of index investing, such as broad diversification to equity exposure and generally lower expenses as compared to actively managed funds.
And so on. https://www.google.com/url?sa=t&rct=j&q ... hf3ClBicf9
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by Daendrew » Fri Sep 28, 2018 7:46 am

I think the biggest benefit to fundamental weighting is avoiding bubbles. If you had been investing in fundamental indexes during the dot com bubble, you would have significantly more money today vs cap weighted. ~30% of the S&P was tech back then IIRC. Fundamental indexing could have also helped you avoid putting half your international investing into Japan in during the mega-bubble of the 80s.

There are sky high tech valuations again. Time will tell if they are a FAANG/tech bubble.

It is pretty impressive that the RAFI index kept up with the S&P 500 while providing some downside protection if there is more frothiness in the tech and growth stock area. We are in a unique period where valuations can be artificially high because there isn't much of a choice where to invest. Bonds and CDs are at historic low payouts.

The price earnings multiple are priced much better at a multiple of 16 in the Schwab Fundamental Large Cap index
https://www.schwabfunds.com/public/csim ... mbol=SFLNX

Versus a multiple of 21 in the Russell 1000
https://institutional.vanguard.com/VGAp ... undId=3348

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by Robert T » Fri Sep 28, 2018 8:26 am

.
The funds have performed as expected.

From the Fundamental Index book (pg 103):
"Because a Fundamental Index portfolio has a value tilt relative to a cap-weighted market, a growth market will help the cap-weighted market relative to a Fundamental Index portfolio"
From pg. 264 of the book. During 1990s Fundamental Index lagged S&P500 by 1.2% per year. Over the last 10 years value has lagged growth.

What the book does say pg. 164:
"as far as we are aware, no other existing index offers a value tilt relative to the cap-weighted markets while avoiding large negative Fama-French alphas."
On avoiding 'negative alpha' it has performed as earlier indicated - see Portfolio Visualizer results below.

https://www.portfoliovisualizer.com/fac ... sion=false

Robert
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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by randomguy » Fri Sep 28, 2018 10:26 am

nisiprius wrote:
Fri Sep 28, 2018 6:29 am
asset_chaos wrote:
Fri Sep 28, 2018 2:43 am
typical.investor wrote:
Thu Sep 27, 2018 8:20 am
I personally wouldn't expect a fundamental index to outperform during a time when growth stocks did so much better. Perhaps that's how they were sold and yes I agree that's dubious marketing.
Maybe I misremember, but I thought Arnott vigorously claimed that fundamental indexing was somehow different from value tilting. Or maybe he claimed that for a while then stopped commenting on the topic. After all, if it's just loading on value, there's nothing terribly remarkable or novel about that, and there are possibly lower cost or better investment vehicles to use to load on value than fundamental indexing. For what it's worth portfoliovisualizer readily affirms that SFLNX has been a large value fund.
1) As I understand it, some people are admiring SFLNX for failing to underperform the S&P 500 index.

2) The Research Affiliates website seems quite clear: RAFI™ Strategies
RAFI™ strategies aim to generate excess returns versus the market benchmark through a systematic, contrarian rebalancing approach.
Their commentary here begins:
The RAFI Fundamental US Index underperformed the Russell 1000 Index by 154 bps...
and doesn't mention other indexes. Although it's not stated explicitly there, I take it that the Russell 1000 Index is "the" market benchmark, relative to which the RAFI Fundamental US Index "aims to generate excess returns."

What was "promised," or at least explicitly stated as an "aim," was not beating a value index. The aim is "excess returns via the market benchmark." I don't think a value index is "the market benchmark." RAFI is supposed to beat the market, period.
And did they promise that every 10 year period would be a period of outperformance or did they say over the long run they will generate excess return.

Imagine we were having this discussion about Small value versus total market in 2000. You would be talking about how total market outperformed by 2%/year for the past 10 years and how the academics were full of it. 10 years later the SV people would be talking about how they averaged 3%/year outperformance over the 20 year period or right about inline with expected results.

Eventually you have to decide if a strategy isn't going to work but 10 year periods of underperformance should not be one of the reasons to lose faith. That is an expected outcome.

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Re: A quick peek at a RAFI Fundamental Large-Cap Index Fund, ten years later

Post by nisiprius » Fri Sep 28, 2018 11:23 am

No, of course nobody promised anything. No, of course ten years isn't enough.

Can we agree that:

a) The RAFI strategy's stated "aim" (not promise) "to generate excess returns versus the market benchmark," (i.e. not versus a value index);

b) For the RAFI US Fundamental Index, the "market benchmark" cited by Research Associates is the Russell 1000 Index (not the Russell 1000 Value Index);

c) Arnott should not have said in 2011 that
...the numbers speak for themselves. The Power Shares FTSE RAFI 1000 ETF [NYSEArca: PRF] recently celebrated its five-year anniversary at the end of 2010. Its cumulative return was just under 4.2 percent a year. That sounds terrible, but the iShares S&P index over the same span was 2.1 percent year."
Five year outperformance does not "speak for itself," (nor does ten-year underperformance).

d) Ludwig (the interviewer) and Arnott agreed that the clincher for RAFI was the ability "to demonstrate lasting success with a fundamentally weighted long-short strategy," that Arnott named the RALS ETF as a valid example of such a strategy in action--and that the performance of the RALS ETF, since inception, has sucked?

e) RAFI has not been a bad strategy so far, and could be a good long-term strategy going forward.
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