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Fundamental indexing trims overextended stocks by economic scale

Research Affiliates says its RAFI approach decouples portfolio weights from stock prices to reduce buy-high, sell-low flip-flops seen in cap-weighted indexes.

Reported · Written up by our desk · Fund Industry

ETF Trends examines how fundamental indexing, built on Research Affiliates’ fundamental indexing methodology (RAFI), differs from traditional market capitalization weighting.

The outlet says RAFI decouples portfolio weight from stock price and selects and rebalances holdings based on real-world economic scale. It also describes RAFI as a disciplined framework that systematically trims overextended stocks and buys underappreciated businesses.

ETF Trends argues that fundamental indexing is not limited to a niche value strategy. It says anchoring weights to economic reality can be used across the style box spectrum, including core and growth exposure through the Research Affiliates Cap-Weighted Index (RACWI) and the RAFI Growth Index (RAFIG).

The piece also contrasts RAFI with traditional style box indexing, which assigns companies using price multiples like price-to-earnings or price-to-book and momentum metrics, and notes that cap-weighted indexes can create performance drag by adding stocks after run-ups and deleting them after steep drops during rebalances, contributing to buy-high, sell-low dynamics.

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