Is there such a thing as a better mouse trap? This week’s Financial Thought Leader guest has created an alternative to traditional index funds. Instead of being based on market capitalization or stock price, his Fundamental Index® approach measures fundamentals such as sales, profits, and dividends to determine the weight securities have in his indexes. Research Affiliates Chairman and CEO Robert Arnott explains why fundamentals can make a big difference.
WEALTHTRACK Episode #1042; Originally Broadcast on April 11, 2014
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Jack, as he is known to many of his colleagues created the first index fund at his firm Vanguard in 1975. His concept was to allow the average investor to invest in the broad market at a very low cost. It took years to catch on, but has it ever!
Equity index funds, including the newer exchange traded funds or ETFs now account for 31% of total equity fund assets- $2.7 trillion worth versus the $6.1 trillion in actively managed funds. The amount of money going into them is also accelerating. Since the financial crisis in 2008 investors have put nearly a trillion dollars into stock index funds and taken more than $300 billion out of actively managed equity funds. As Bogle points out, that is a cumulative shift in investor preference of more than $1.2 trillion dollars!
My issue with index funds has always been, why do we have to settle for market performance? Why in the glorious history of human accomplishment is investing the one area where average is really the best that we can do? Another problem is that traditional index funds are what are known as “capitalization weighted,” which means the more expensive the stock and greater the number of shares outstanding the bigger the weighting they have in the index.
A great example of the pitfalls of weighting securities by price is what happened in the tech bubble. By its peak in 1999 technology stocks as a percentage of the S&P 500 index fund had gone from a weighting of 11% in 1989 to more than 25% in 1999. If you were invested in Bogle’s original Vanguard 500 index fund you were tech heavy at the peak and got massacred when the sector crashed. What happened to financial stocks in the last decade is another disturbing example. You would have had 20% or more of your portfolio in financial stocks which then cratered during the financial crisis.
So is there a better mousetrap?
Today’s Financial Thought Leader guest says there is. He is Robert Arnott, Chairman and CEO of Research Affiliates, which he founded in 2002 as a self-described, “research intensive asset management firm that focuses on innovative products”. Among the unconventional portfolio strategies that Arnott has pioneered are tactical asset allocation and the Fundamental Index approach to indexation. Products based on the firm’s fundamental index approach, known as RAFI passed the $100 billion mark last year.
Arnott will discuss some of his astonishing research results on indexing and respond to some critics of his fundamental approach including James Montier who works with Jeremy Grantham at GMO. If you register at www.gmo.com you can read Montier’s White Paper, “No Silver Bullets in Investing (just old snake oil in new bottles).” Registration is free and gives you access to other GMO reports as well.
When you have a chance we also invite you to explore a new section on our website. It is called WEALTHTRACK WOMEN. We have interviewed a group of experienced women advisors who specialize in helping women plan their financial futures. Every week they will address specific issues and concerns raised by their women clients.
Have a great weekend and make the week ahead a profitable and productive one!
Be Open To New Investment Ideas But Don’t Bet The Farm On Them
-Fundamental Indexation – Weights stocks based on key fundamentals, not price. -Fundamentals can include revenues, earnings, cash flow, book value, dividends, etc.
Fear Creates Bargains
Consider Emerging Markets Stocks and Bonds
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Two Veteran Value Investors – Susan Byrne & Rob Arnott
Two veteran value investors tell us where they see the investment clouds clearing. Value investor Susan Byrne is finding companies with sound balance sheets and good cash flow that should withstand difficult times. Long-time bear Rob Arnott finally sees good values in the fixed-income markets. Find out where they see the profit opportunities.
What does Financial Thought Leader and portfolio manager Arnott do to unwind from his intensive schedule of research, investing and financial innovation? He describes his “geeky hobby.”