An interesting development cropped up last week. Russell Investments (USA) and Research Affiliates® (creators of the Fundamental Index® methodology) have partnered up to launch a new set of fundamentally weighted indexes. It’s interesting for a few reasons:
1. Russell is knownwidely for its cap-weighted indexes (Russell 1000, 2000, 3000, etc.)
2. Russell (Canada) is also known for being a provider of active management in Canada through its Lifepoints and Sovereign programs. Here is a quote from their Canadian website:
Our investment philosophy is rooted in the belief that financial markets reward knowledgeable, disciplined investors. Based on a philosophy that over a long period of time active managers can add value, Russell selects teams of money managers to meet clients’ investment goals. We aim to reduce risk and provide benchmark-beating returns both collectively and over time.
3. The new fundamentally weighted indexes use 3 factors which are different than the ones found in the FTSE RAFI series.
So Why Is This Interesting?
It’s yet another warning shot that market-capitalization weighted indexes are under fire. Cap-weighted indexes were never designed as investable strategies, but have become synonymous with passive investing. (Disclosure: I work for a company that provides fundamental indexing, and my own portfolio holds fundamental indexes, and I personally believe they are superior as an investment strategy than cap-weighted indexes.)
Perhaps this development is a canary in the coal mine that an “all active, all the time” mentality is finally dying (as it should). I think this is both good for investors and good for Russell.
Details of what factors will be used for the Russell Fundamental Index series are scheduled to be released in Q3.
So are there long term time neutral comparisons between market weighted and fundamental index investing?
Markets go up – FI does better (can include many small companies)
Markets go down – MW does better (“bigger = safer”)
It all just evens out eventually especially given the higher fees for FI.
Hi Tim, thanks for your comment. I have data from Research Affiliates going back to 1962, which is also published in a peer reviewed academic journal. They have a great scatter plot which shows what I think you are looking for. I’ll dig it up if you are truly interested in seeing it. It compares three year annualized returns for FI vs CW on a rolling basis, back to 1962.
Your two points are almost backwards with respect to the comparison between the two methodologies. In most down markets, FI wins. Only during raging bull markets do we start to see CW winning – this is because CW places more and more weight on growth companies. The estimated alpha is 2-3% domestically and approaching 10% in emerging markets. The outperformance is a function of the degree of pricing error in the markets, hence the more “efficient” a market is, the less alpha. Even at 2-3%, this is enough to overcome the additional cost.