Fundamental Indexing

Frequently Asked Questions

How much churn is there in a Fundamental Index?

As most enterprises' share prices loosely follow their economic scale, annual turnover in a fundamental index remains low - almost as low as cap-weighted indices. Currently our Top 40 cap-weighted tracker portfolio has an annual turnover of approximately 16% a year (including dividend re-investment). In comparison, the Old Mutual RAFI^® 40 Tracker Fund to have a churn of not more than 20% a year - this is low relative to the average estimated General Equity unit trust turnover of close to 100% a year.

Will this concept miss a run in growth counters?

Historical studies across all markets show that the long-term return of a growth-skewed portfolio will inevitably underperform. The key to answering this question is "time frame" - over the short-term there is no doubt that a Fundamental Index will underweight overvalued growth stocks and will lag a cap-weight Index. However, over the long-term, these stocks typically revert back to their actual intrinsic value - resulting in underperformance.

It should also be noted that the Fundamental Index does not ignore exciting grow stocks if they are producing good cash flows etc. For more information, view the current constituents of the FTSE/JSE RAFI^® Top 40 Index.

Is liquidity materially reduced in the Fundamental Indices?

When the index is constructed, a liquidity factor is applied to the RAFI factor. From the range of current constituents of the FTSE/JSE RAFI^® Top 40 Index it is evident that highly liquid stocks are included.

Can the four factors be effectively applied to the South African market?

The historical retrospective performance is a good barometer that the factors can be effectively applied to South African market. These factors strip-out accounting differences no matter what economy you are looking at!

Why is a five-year trailing average used for the factors?

Five-year trailing average data is used for the four factors to minimise the substantial volatility in the index factors that would result from using year-to-year data. This also reduces the rebalancing turnover.

Will a five-year average result in missed opportunities?

A company that has generated vastly improved short-term cash flows, sales and dividends will need to do so consistently for at least three years before the RAFI factors start to reward the company with a higher weighting. Conversely, a cap-weight index will immediately reward the stock with a higher weighting.

The purpose of the Fundamental Index concept is to not chase short-term winners - vastly improved sales performance this year will not necessarily translate into improved sales in year two.

We believe that the ideal portfolio includes a blend of active and passive funds.  The more expensive active portfolios will seek out these shorter-term growth opportunities while a low cost Fundamental Index tracker fund will typically be used as the core equity component of a fund - providing a superior, risk-adjusted long-term return.