Monday, December 13, 2010

FT: Rafi indices

This year an alternative has started to take off. California’s Research Affiliates created the idea in 2005 with its Rafi fundamental indices, and new indices which are not cap-weighted have since sprung up. Money tracking fundamental indices has almost doubled this year, to about $50bn, and the topic is on every big pension fund’s agenda.

Behind the new-found popularity of the indices is their trouncing of normal indexes. The FTSE Rafi US index stands out, having risen 39 per cent last year, against 26 per cent for the Wilshire 5000 actively traded US stocks. The 2009 performance was down to luck, rather than judgment, as it happened to rebalance in March, at the bottom of the market. But other years, and backtesting, suggest a return in developed markets a couple of percentage points ahead of cap-weighted indices.

The basic idea behind fundamental indices is that companies should be invested in according to their real world size, not their market value. That can be measured by earnings, dividends, revenues, or even employee numbers (Taiwan is about to launch a Rafi index based on staff numbers).

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