Research Affiliates Has a New Feather in Its Cap-Weighted Line

Research Affiliates dropped a new ETF Friday that its founder says has the most important change to indexing in decades — and for a limited time, it’s free.

The firm’s new Research Affiliates Cap-Weighted US ETF (RAUS) uses an index that takes a different approach to stock inclusion, relying on factors like sales, cash flow, dividends and buybacks and book value. Compared with traditional market-cap weighting, that minimizes turnover and keeps the fund from buying high and selling low, Research Affiliates’ founder and chairman Rob Arnott said. “People think of active versus passive as a binary choice, and it’s not. There is no such thing as a passive investment,” Arnott said, pointing to any index fund’s turnover of 5% or or so as being the active component. 

“The 5% active looks like a wild-eyed emerging growth investment manager on crystal meth,” he said. “You’re buying stocks at frothy valuations … after a period of stupendous performance.”

You Had Me at ‘Sell Low’

Typical large-cap index funds also scrap stocks after poor performance, selling them at a discount, and in some cases adding them back later, Arnott noted. The fund tracks the RACWI US Index, which the firm launched in 2021. So far, that index hasn’t been used for any products, although the global version of it is used by a Swiss family office that accounts for most of the $1.5 billion in the strategy, Arnott said. Applying historical performance to the RACWI US Index, it would have had excess returns of 0.69% annually from July 1991 to December 2024 compared with the S&P 500, and with compounding, that would lead to 23% more wealth, according to a paper Research Affiliates posted. “I will humbly say, ‘This is the most important advance in cap weight indexing in decades,’” Arnott said.

While the ETF has a management fee of 0.15%, that is being waived for the first year, after which the net fee will likely increase, eventually leveling out in the high single-digit range, Arnott said. The 0.15% level was set because it is difficult to raise fees on an ETF, as doing so requires a shareholder vote, he noted. “We decided, while the fund is small and the costs will exceed the fees anyway, why not thank our early adopters with free fees for the first year.”

Some of the stocks in RACWI differ from those in the S&P 500:

• The largest stocks included in it, but not the S&P 500, are Marvell Technology, CRH, Cheniere Energy and Flutter Entertainment.
• The biggest names excluded from it are Palantir, CrowdStrike, DoorDash and Royal Caribbean.

Remember ‘Smart Beta’? Demand for so-called smart-beta strategies has waned in the 2020s, and anything related to that category is going to have challenges getting investors’ attention, said Dan Sotiroff, senior analyst of passive strategies at Morningstar. While the fund’s screening strategy is reasonable and elements of it look attractive, it will have to prove itself going forward, as backtesting can’t necessarily predict future performance, he said. “We want to see that that’s something that’s repeatable,” he said. “It’s reasonable to be cautious around anything that claims to generate alpha.”