RAFI ETFs YTD: Boom Or Bust?
Wed, Oct 24, 9:15 AM ET, by Michael Johnston
As the ETF industry continues to develop, many investors have begun to move away from the more “traditional” funds in favor of ETFs that employ unique methodologies that are aimed at delivering potentially higher returns. Of the most noteworthy and popular innovations has been the development of alternative weighting strategies, specifically the RAFI methodology [see 101 ETF Lessons Every Advisor Should Learn].
Several years ago, Research Affiliates, a global lead in innovative investing and asset allocation strategies, developed the fundamentally-weighted indexes that utilize the RAFI methodology. Now there are nearly 20 different exchange-traded products that are linked to RAFI-weighted indexes. But before taking a look at the performance of these popular funds, a fundamental understanding of the unique methodology is essential.
Understanding RAFI
The RAFI weighting methodology is relatively straightforward. While traditional cap- weighted indexes determine allocations based on market capitalization, RAFI funds take into account several fundamental factors to determine the weighting of an individual holding. These factors include cash flow, book value, sales and dividends [see also RAFI ETFdb Portfolio].
The primary criticism of market capitalization weighted indexes is that there is a direct relationship between stock price and the weighting assigned. The RAFI methodology’s goal is to effectively break the link between share price and weight within an index. And while cap-weighting features a number of potential advantages - such as low cost and maintenance - their noteworthy drawbacks warrant investors to perhaps take a look alternative strategies, such as RAFI. For example, cap-weighted methodologies tend to overweight overvalued stocks and underweight undervalued ones, which can obviously create a potential drag on returns.
A look at the performance of these fundamentally-weighted ETFs in comparison to their cap-weighted counterparts highlights the impact of weighting methodologies on bottom line returns [see the best performing ETFs in 2012].
How Do RAFI ETFs Stack Up YTD?
| Ticker |
RAFI Index |
RAFI ETF YTD |
Cap-Weighted Index |
Cap-Weighted Index YTD |
| PRF |
FTSE RAFI 1000 |
15.36% |
Russell 1000 Index |
16.28% |
| PXF |
FTSE RAFI Developed Markets ex-U.S. |
10.61% |
MSCI EAFE Index |
9.48% |
| PAF |
FTSE RAFI Asia Pacific ex-Japan |
17.38% |
MSCI AC Asia Pacific ex-Japan |
13.21% |
| PXH |
FTSE RAFI Emerging Markets |
9.05% |
MSCI Emerging Markets |
9.92% |
| PDN |
FTSE RAFI Developed ex-U.S. Small-Mid |
10.31% |
MSCI EAFE Small Cap |
12.66% |
| PRFZ |
FTSE RAFI U.S. 1500 Small-Mid |
12.19% |
Russell 2000 |
14.23% |
| *Year-to-date returns as of 10/22/2012 |
Out of six Powershares RAFI ETFs, only two funds have outperformed their corresponding cap-weighted indexes; the FTSE RAFI Developed Markets ex-U.S. (PXF) and FTSE RAFI Asia Pacific ex-Japan (PAF) ETFs. The underperforming RAFI ETFs do not, however, trail far behind their cap-weighted competitors. But for those cost-conscious investors, the high price tag on these ETFs, which average around 0.75% to 0.8%, may not be worth it since only a few have proven that the RAFI methodology trumps traditionally-weighted indexes.
| |
Value |
YTD |
Core |
YTD |
Growth |
YTD |
| Large |
Fundamental Pure Large Value Portfolio (PXLV) |
16.27% |
Fundamental Pure Large Core Portfolio (PXLC) |
13.55% |
Fundamental Pure Large Growth Portfolio (PXLG) |
18.05% |
| Mid |
Fundamental Pure Mid Value Portfolio (PXMV) |
15.64% |
Fundamental Pure Mid Core Portfolio (PXMC) |
9.89% |
Fundamental Pure Mid Growth Portfolio (PXMG) |
9.40% |
| Small |
Fundamental Pure Small Value Portfolio (PXSV) |
14.28% |
Fundamental Pure Small Core Portfolio (PXSC) |
9.29% |
Fundamental Pure Small Growth Portfolio (PXSG) |
10.26% |
| *Year-to-date returns as of 10/22/2012 |
PowerShares’ lineup of value, core and growth “Fundamental Pure” ETFs have certainly raised the bar in 2012, delivering double digit year-to-date returns. Of the lot, the large-cap focused funds have all outperformed their mid and small-cap counterparts across all three investment styles. Thus far in 2012, the biggest winner has been the RAFI Fundamental Pure Large Growth Portfolio (PXLG) with its whopping 18.05% year-to-date return [see Free Report: How To Pick The Right ETF Every Time].
| Ticker |
ETF |
YTD |
| PHB |
Fundamental High Yield Corporate Bond Portfolio |
8.64% |
| PFIG |
Fundamental Investment Grade Corporate Bond Portfolio |
5.21% |
| *Year-to-date returns as of 10/22/2012 |
For those looking for fixed income exposure, perhaps the RAFI methodology is not the best option, as year-to-date returns are significantly lagging in comparison to other funds in PHB’s and PFIG’s respective categories.
While the fundamentally-weighted PHB does offer a relatively handsome 8.92% return, the comparable SPDR Barclays Capital High Yield Bond ETF [etf ticker='JNK' ratings='true'] has logged in gains of 11.02% thus far in 2012. And in regards to PFIG, the ultra popular iBoxx $ Investment Grade Corporate Bond Fund [etf ticker='LQD' ratings='true'] has delivered year-to-date returns of 10.95%, nearly double that of PFIG’s [see also 5 High Yielding Real Estate ETFs].
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Disclosure: No positions at time of writing.
Click here to read the original article on ETFdb.com. 
SDI Glossary: "Bond" Definition
SDI Glossary: "price" Definition
SDI Glossary: "ETFs" Definition
SDI Glossary: "Yield" Definition
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