Traditional passive investment vehicles are market capitalization–weighted, which means that as the price of a company increases so does its overall weight in the portfolio. The result is a systematic overweight to the most overvalued companies and a systematic underweight to the most undervalued companies.
The RAFI Fundamental Index is a non-price-weighted index strategy that aims to deliver excess returns versus the cap-weighted benchmark. The strategy uses fundamental measures of company size to select and weight companies and to systematically rebalance against the market’s constantly shifting expectations. The approach eliminates the performance drag associated with traditional passive investment vehicles and has historically led to outperformance in developed markets of approximately 1.5%–2.0% a year.1
1. “Fundamental Indexation.” 2005. Arnott, Hsu, and Moore.