- RAFI Fundamental Index offers an excess return with all the benefits investors expect from traditional passive indexing: simple, intuitive, low cost, transparent, high capacity, and representative of the broad market.
- RAFI Dynamic Multi-Factor is designed to offer diversified factor exposure and a smoother ride over a full market cycle relative to a cap-weighted benchmark, and is well suited to investors comfortable taking on greater complexity for the potential of added return.
- RAFI and RAFI Dynamic Multi-Factor have different risk and return characteristics. The investor’s objectives and governance mechanism should guide their selection of strategy.
Investors, when making asset allocation decisions, look beyond returns and seek to accommodate their own unique constraints and governance requirements. These investor-specific preferences—such as generating income, limiting downside risk, or controlling tracking error—significantly influence how investment decisions are made. At Research Affiliates we strongly believe that “Investor preferences are broader than risk and return.”1 Thus, finding the right fit in terms of strategy is crucial to investors’ long-term success, comfort, and satisfaction with their investment decisions.
A survey of the smart beta landscape reveals a myriad of strategy choices available to investors, each designed to appeal to (and some to arguably prey on) the wide range of investor preferences. Investors should be diligent in educating themselves about which is right for them. We find ourselves fielding questions about the differences between the RAFI™ Fundamental Index™ strategy and our recently launched RAFI Multi-Factor Index series.2 In this article we provide an overview of both methodologies, examining their respective characteristics and benefits, so the reader can make the final call on which strategy best suits their needs.
RAFI Fundamental Index
Since the launch of the first RAFI Fundamental Index (RAFI) strategies in 2005 by FTSE Russell, RAFI has been one of the leaders in the move beyond conventional indexing and active management. The RAFI methodology is relatively simple. It selects and weights securities by fundamental measures of company size such as delevered sales, cash flow, dividends + buybacks, and book value.3 Instead of mirroring the look and composition of the cap-weighted market, RAFI mirrors the look and composition of the macroeconomy.
RAFI is built on the principles of contrarian investing and disciplined rebalancing. It aims to deliver excess return over the cap-weighted benchmark by systematically rebalancing out of the trendy, popular, and most expensive securities, and into securities whose prices have fallen and become undervalued. With a live track record over a decade long, RAFI has proven its efficacy and still has all the benefits of traditional passive investing: simplicity in construction, full transparency, broad diversification, representative of the macroeconomy, low cost, and high investment capacity.
RAFI Dynamic Multi-Factor Index
The RAFI Dynamic Multi-Factor Index strategy is a rules-based, transparent smart beta index that offers diversified factor exposures through a combination of five theoretically sound and empirically robust single-factor strategies: value, low volatility, quality, momentum, and size. Each factor is constructed by selecting the top 25% of the security universe by factor definition4 (e.g., systematic risk for low volatility and high profitability, and low investment for quality) in order to create targeted and concentrated factor exposures.5 Through concentrated exposures across diversified factors, RAFI Dynamic Multi-Factor is expected to offer higher returns. A smoother ride is achieved over time relative to strategies that rely on a single factor because the five factors have moderate to low correlations of excess returns. In addition, the RAFI Dynamic Multi-Factor strategy offers the potential for added return through a dynamic weighting process that allocates to factors particularly attractive on a forward-looking basis.6