Fundamental growth indexing outperforms cap-weighting
The guest argued that selecting growth stocks based on fundamental growth metrics and weighting them by their absolute dollar contribution to economic growth outperforms traditional cap-weighted growth indexes.
The argument
Rob Arnott of Research Affiliates explained that traditional cap-weighted indexes create concentration risk and over-allocate to expensive stocks. By selecting companies based on percentage growth in sales, profits, and R&D, and weighting them by the absolute dollar magnitude of that growth, investors can capture fundamental economic expansion with less valuation froth.
The thesis, stress-tested
✓ What validates it
- ✓Launch of a public ETF or mutual fund tracking the RAFIG index
- ✓Continued tracking data showing RAFIG outperforming the Russell Growth Index over a multi-year horizon
▸ Risks discussed
- ▸Higher volatility than traditional cap-weighted indexes
- ▸Higher turnover (4-5x of S&P 500) which reduces capacity to 10-20% of S&P 500
- ▸Periods of underperformance during certain market regimes
Hear it yourself
"the MAG seven, higher valuations, and increased risks for investors. How should an index investor think about this? Well, to help us unpack all of it and what it means for your portfolio, let's bring in Rob Arnott, founder of Research Affiliates. The firm recently put out the Research Affiliates growth index that's different from both cap weighted ETFs, but also different from equal weight ETFs. So I'm fascinated by this index which you guys put out. You're tracking it live today. It's not yet investable, but I assume there'll be an ETF out sooner rather than later."
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