Arnott vs. Siegel: The Fundamental Indexation Battle Begins

Let’s get ready to rumble. Non-market cap weighted indexation is starting to heat up even futher. DFA started it a long time ago. Rydex brought out RSP a little over 3 years ago.

Rob Arnott has been talking about fundamental indexation for a few years now, and his firm Research Affiliates teamed up with index provider FTSE and manufacturer PowerShares to provide the first “fundamentally based” index ETF with The PowerShares FTSE™ RAFI US 1000 Portfolio (PRF).

With WisdomTree’s version of fundamental indexation based on the research of Professor Jeremy Siegel (focused on dividends, while Arnott’s version is based on four fundamental factors: book value, income, sales and dividends) launched just last month, PowerShares has countered with news of the registration with the SEC for ten new funds. Again they will be branded as PowerShares FTSE™ RAFI Portfolios but will cover nine sectors. One will cover small-mid caps. Here’s the list:

* FTSE RAFI Basic Materials Sector Portfolio
* FTSE RAFI Consumer Goods Sector Portfolio
* FTSE RAFI Consumer Services Sector Portfolio
* FTSE RAFI Energy Sector Portfolio
* FTSE RAFI Financials Sector Portfolio
* FTSE RAFI Health Care Sector Portfolio
* FTSE RAFI Industrials Sector Portfolio
* FTSE RAFI Telecommunications & Technology Sector
* FTSE RAFI US 1500 Small-Mid Portfolio
* FTSE RAFI Utilities Sector Portfolio

It will be very interesting to see the growth in assets in these funds versus those of WisdomTree. One thing that has always been an important truth in the ETF industry is that first to market matters. Consider GLD versus IAU. In this case however, there is more of a fundamental (sorry) difference between what WisdomTree and PowerShares are providing.

Side note: PowerShares is reportedly registering 31 new funds with the SEC, including those mentioned above. The vast majority of these new funds (all but 6) are sector funds. Question: Don’t we already have enough sector based ETFs? If they don’t have comparable MERs or cover new territory (geographic or otherwise), you really have to wonder. The one that really gets my interest is the Cleantech ETF. I’d like to add that to our PBW position.

Comments

[Roger Nusbaum:]

FWIW, Arnott says his methodology works for foriegn markets. I saw him speak a few months ago and he said that they have studied quite a few countries for this. There may be country ETFs coming as a result of this.

Single country funds seem to have been forgotten about in the innovation wave.

2006 Jul 06 12:31 PM

[Richard Kang1:]

Roger, I've rarely used country specific positions for our clients (of course Canada and the US, Japan as well). It's been a lot of regions EAFE, Pacific ex-Japan, etc. I'd have no problems with more country based ETFs if that's what the market is asking for. I'm more interested in coverage to broader geographic areas. Central/Eastern Europe is a good example although their gains rank up there with Latin America and other EM zones. But sometimes, the logical isn't that great ... I'm thinking BRIC. Sounds good when you think about it, but I'd rather have access to the country ETFs directly in this case.

Btw, yours is a really great blog site ranked in my "favorites list" right up there with Ritholtz, Kirk and very few others.

2006 Jul 07 01:43 AM

[Robert Coleman:]

Theory is missing from the data-driven analysis of fundamental indexation. The fatal problems with dividends and certain other so-called fundamental metrics for either selecting stocks or weighting stocks in a portfolio have been analyzed with theory in mind. To avoid excessive repetition here, the full analysis can be found at the following webpage.

At numeraire.com/download... there are documents about the fatal fallacy of dividends and other factors: WSJ letter; WSJ article; WSJ.com article, and blogs. The WSJ letter to the editor is a response to the WSJ Op-Ed article, which in turn is a response to the WSJ.com Commentary article. These documents are supported by two published articles also available at the numeraire.com webpage: IJEB in June, 2005; and AEF in May, 2006.

To facilitate fair, open discussion about this matter among interested persons, one of the linked documents (labeled "blogs") at the numeraire.com webpage includes comments by bloggers. I trust this conforms to fair use pursuant to The Chicago Manual of Style, 14/e.

2006 Jul 06 07:16 PM