When Rob Arnott talks about the money that has been attracted to Research Affiliates’ various investment vehicles, he talks about billions of dollars. For example, since launching the RAFI—Research Affiliates Fundamental Indexes—approach to portfolio building five years ago, he said $54 billion in RAFI assets were now being managed or sub-advised by Research Affiliates and RAFI licensees.
He’s feeling good about the worldwide embrace of the practical notion of fundamentals-based indexing rather than cap-weighted indexing and thinks that growth will continue. But in an interview with AdvisorOne in New York on Wednesday, with talk of the U.S. debt ceiling filling the airwaves and corridors of the U.S. Capitol, the chairman of Research Affiliates and the driving force behind the fundamental indexing approach was talking about trillions of dollars. As in the level of federal debt.
“It’s an untenable situation,” said Arnott (left), referring not merely to the controversy over the debt ceiling but over the amount of government spending. The most serious issue right now, he said, is the United States’ AAA rating, and he says that merely raising the debt ceiling won’t mollify the ratings agencies, which already have the U.S. on watch for a possible downgrade. “We’ve got to keep our rating,” he says, recalling that “S&P was explicit” in its warning: “Get the spending reined in,” and at the $4 trillion level. None of the competing debt packages now being floated in Washington, he points out, is looking for $4 trillion in cuts.
(In testimony on Wednesday before a House Financial Services Committee panel, S&P President Deven Sharma sought to clarify what he suggested were misleading media reports about the $4 trillion figure, saying that number was only “within the threshold” of what the ratings agency thought was necessary for the U.S. to retain its AAA rating. Furthermore, Sharma said that “some of the plans” now being floated by the two parties in Washington could put the country’s debt outlook “in the range of the threshold of a triple-A rating.”)
While it remains unclear whether a downgrade will happen regardless of what transpires in Washington regarding the debt ceiling, Arnott suggested that one possible solution to appeasing the ratings agencies might come in the form of legislation—Ensuring the Full Faith and Credit of the U.S., or S. 63—proposed by Sen. Pat Toomey, R-Pa., originally in February and reintroduced Tuesday with 31 cosponsors in the Senate.
Under that bill, the government would be forced to make three of its debt obligations “sacrosanct”: paying debt service, funding Social Security and paying active-duty military, Arnott said. The government’s income would be sufficient to make those payments, he said, and could provide some breathing room to address the broader spending issues faced by the country.