Effects of Valuation
Focusing on current valuations relative to a strategy’s or factor’s history, rather than its historical performance,
enables investors to better assess the potential for future excess returns.
Logically, investors have a better chance of generating a premium if they can eventually sell assets at a higher price than those prevailing at the time of purchase. Yet many investors fail to link the initial valuations of assets and factors to forward-looking return prospects and thus engage in performance chasing. The result is exactly the opposite of what investors wish to achieve—selling low and buying high! At RAFI Indices and our sister company, Research Affiliates, we endeavor to reverse this behavior and encourage investors to focus on current valuations relative to a strategy’s or factor’s history rather than historical performance. In doing so, an investor is better able to assess the potential for future excess returns.
Research Affiliates, our sister company, has published a number of articles summarizing our views on valuations. The Research Affiliates Smart Beta Interactive tool is also an excellent resource for investors in researching valuations across a number of factors and smart beta strategies.