Traditional passive investment vehicles are market capitalization–weighted, which means that as the price of a company increases so does its overall weight in the portfolio. The result is a systematic overweight to the most overvalued companies and a systematic underweight to the most undervalued companies.

The RAFI Fundamental Select Index is a non-price-weighted index strategy that aims to deliver excess returns versus the cap-weighted benchmark. The strategy uses fundamental measures of company size to select and weight companies and to systematically rebalance against the market’s constantly shifting expectations. The approach seeks to eliminate the performance drag associated with traditional passive investment vehicles and has historically led to outperformance in developed markets of approximately 1.5%–2.0% a year.¹

1. “Fundamental Indexation.”  2005. Arnott, Hsu, and Moore.

• Breaks the link between price and weight.
  Using fundamental measures of company size to sever the link between price (market capitalization) and portfolio weight avoids significant overweights to the trendy, popular, and most expensive securities.
• Engages in contrarian rebalancing.
  Systematic rebalancing using a company’s fundamental weight as a rebalancing anchor embeds a buy-low, sell-high approach in the strategy, selling securities whose prices have increased and purchasing securities whose prices have fallen and thus have more attractive relative equity valuations.
• Benefits the investor.
  Preserving all the positives of traditional passive investing—simple, transparent, broadly diversified, and low cost—as well as using regular periodic rebalancing may help investors capture excess return from long-term mean reversion, one of the largest and most persistent active investment opportunities.