What is RAFI fundamental indexing?

Claymore Investments, Inc. 14 May, 2010 | 3:20AM

There is a growing movement by institutional and retail investors globally to a new form of indexing called fundamental indexing, which has been designed to improve upon traditional market-cap-weighted indexes.

The Research Affiliates Fundamental Index -- or RAFI -- methodology is radical in its simplicity. Instead of selecting and weighting companies based on market capitalization, The RAFI Indexes select and weights companies based on four financial factors of a company's size that are price-indifferent:

  • Total sales
  • Total cash flow
  • Total gross dividends paid
  • Book equity value

By breaking the link between the price and the weight of holdings within an index, the RAFI Fundamental Index strategy weights and rebalances itself based on the company's fundamentals and has consistently avoided overweighting overvalued stocks or sectors, and underweighting undervalued stocks or sectors. Over time, this rebalance is what can lead to outperformance and lower volatility than traditional market-cap-weighted indexes. Of course, as with all investments, past performance may not be repeated and is no guarantee of future results.

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Claymore Investments, Inc.

Claymore Investments, Inc.