Research Affiliates: RAFI Fundamental Growth Outperforms Glamour Stocks

Research Affiliates presented its case during a webinar titled Growth vs Glamour: Rethinking What Drives Equity Returns, delivered by founder Rob Arnott and partner Brent Leadbetter. The firm said the RAFI Fundamental Growth index, which weights companies by dollar sales, profits and R&D, would have returned 77% from 1998 through 2001 while the Russell Growth index produced a negative return.

The RAFI Fundamental Growth Index selects and weights firms using three equal signals: trailing sales, profitability and R&D measured in dollar terms. Research Affiliates contrasted that approach with the common practice of labeling growth stocks by high valuation multiples and weighting by market capitalization. The firm reported back-tested results using data that extend to 1969.

Research Affiliates’ historical tests separated stocks by two dimensions-growth versus slow growth and cheap versus expensive-and identified a ‘‘slow growth/expensive’’ or glamour bucket. Over a 57-year sample, that glamour group lagged the broad market by roughly two percentage points per year compounded, according to the firm’s analysis. The firm said the RAFI approach outperformed the Russell Growth index in the 1998–1999 period and provided downside protection during the subsequent crash, producing a 77% return for 1998–2001 while the Russell Growth index lost value.

The current RAFI portfolio is overweight Alphabet and Meta on the basis of their trailing dollar contributions to sales and profits and excludes some large peers, including Amazon and Microsoft, where dollar growth measures did not rank in the top quartile. During the webinar Arnott stated, “Expensive is expensive. Expensive isn’t growth.” He recommended weighting growth exposure by realized dollar growth rather than by market value, adding that past growth can be a more reliable indicator than paying for expected growth through high valuation multiples.

Research Affiliates has published a working paper and supporting materials that outline the index methodology and the historical tests for investors seeking technical details.