If, 20 years ago, you had divided a pile of greenbacks in two, putting one half in the S&P 500 and one half in the RAFI Fundamental US Index, the latter pile would have grown considerably faster. By the end of October 2011, it would actually be double the size of the standard pile.
You probably don't know this particular index, so let me explain. Some 15-16 years ago, the concept of fundamental indexation was introduced by Research Affiliates founder Robert Arnott and two colleagues, who subsequently launched related indices. With these indices, stocks are weighted by fundamental factors – typically accounting figures like revenues, cash flow, shareholder payments and book value – instead of market capitalization.
It certainly made some sense. By definition, overpriced stocks are overweighted in the standard market cap weighted indices, like S&P 500. A research paper demonstrated that the strategy would have worked for more than four decades (older figures than that were not available). And the subsequent reality test seemed to prove him right.
As you will have divined by now, the index didn't exist in 2000 and there was obviously no pile to be made. However, the methodology has been used to extend the index calculation backwards, demonstrating its superiority in practice for a number of years.
Well ... no more. It's actually been lagging for some time, and the slippage is accelerating. In relative terms, 2020 has been a disaster – and August is no exception. While the S&P 500 can boast a total return year to date of 10%, the fundamental index is 4% in the red.
What's up?
Obviously, fundamental aspects of the listed companies have diminished in importance. Investors seem more concerned with growth – anticipated growth, that is – and cool investment stories. Actual figures are clearly less important.
If this lament sounds vaguely familiar, I might add that critics were quick to call fundamental indexation "an active value strategy in disguise". They certainly had a point. In a sense, such indices only differed from standard indices because of different valuation ratios.
Put another way: This year, it seems, investors have been unusually indifferent to the value of the companies they have bought.
I'm excited to see how long that can last.
Finn Øystein Bergh
Chief Economist & Strategist
Historical returns are no guarantee for future returns. Future returns will depend, inter alia, on, market developments, the portfolio manager’s skill, the fund’s risk profile, as well as fees for subscription, management and redemption. Returns may become negative as a result of negative price developments. This is marketing communication.