This news originally appeared on WealthManagerWeb.com on 11/20/09.

Research Affiliates has received a patent on its Research Affiliates Fundamental Index (RAFI), for the way it creates its fundamentally-weighted indexes. Rather than weighting the indexes based on companies’ market capitalization, the RAFI indexes use fundamental measures of company growth, including cash flow, sales, book value and dividends.

Research Affiliates Founder and Chairman, Rob Arnott, said in the announcement: “Our business model differs from most registered investment advisors, in that our core business is developing and licensing new product ideas. So, unlike most asset managers, we have only our ideas to sell; we can protect these ideas as trade secrets or with patents. As we want to encourage wide use of these ideas, we favor the latter.”

Although he is a fan of index investing and how index funds “have served investors well for over 25 years, providing broad stock market exposure at a fraction of the price of actively managed funds,” Arnott notes that fundamentally-weighted indexes tend to outperform cap-weighted indexes over the long-term because by their nature cap-weighted indexes have a “structural flaw.” They tend to overweight “overpriced securities,” and underweight, “underpriced securities.” The company’s Web site says, “a Fundamental Index portfolio outperformed a comparable cap-weighted portfolio of U.S. large company equities by over 2% annually over the 43 years tested.” (For information on fundamental index performance relative to cap-weighted indexes please go to Research Affiliates.)

For more on fundamental indexing and Rob Arnott:

A Podcast with Rob Arnott on “Fundamental Indexing,” please click here.

“Built to Last” Investment Advisor, January 2008


Kate McBride is editor in chief of WealthManagerWeb.com and a member of The Committee for the Fiduciary Standard.