Rocking with RAFI: International Evidence

Key Points

  • Inherently tilted toward value, the Research Affiliates Fundamental Index™ (RAFI™) weights constituents based on their economic significance and captures rebalancing alpha by contra-trading against cap-weighted indices’ largest holdings.

  • With negligible incremental risk, a RAFI Global Index hypothetically outperformed a Cap-Weighted Global Index by 40 bps per annum and a Cap-Weighted Global Value Index by 2.2% from 2007 to 2022—a 16-year period covering the long value rout and its aftermath.

  • From 2007 to 2022, RAFI outperformed cap-weighted Broad and Value indices in Emerging as well as Developed ex US markets.

  • In the 2010s, value stocks crashed, relative to growth stocks and to the broad cap-weighted market, but value companies continued to pay out dividends.

When we launched RAFI (Research Affiliates Fundamental Index) in 2004, we knew the strategy had the potential to upend the way investors thought about index funds. From the early days of RAFI, some competitors attacked us for having the audacity to suggest that RAFI is a better index, calling it a clever repackaging of a value strategy. True, in part: RAFI has a stark value tilt, which is an exact mirror-image of the cap-weighted market’s willingness to pay a premium for perceived growth opportunities.

In those same early days, however, many recognized that the Fundamental Index approach offered investors the ability to capture rebalancing alpha by contra trading against a cap-weighted index’s biggest bets. Case in point: in 2007, Towers Watson coined the term smart beta, inspired by RAFI, to cover indices that did not link a stock’s price or market cap to its portfolio weight, and therefore enjoyed a rebalancing alpha. The performance of the Fundamental Index was attracting attention and investors.