Indexing Redefined, Part II: Core, Value, & Growth Exposure

In Part I of Indexing Redefined , the foundational strategies comprising Research Affiliates’ fundamental indexing methodology (RAFI) were introduced. More specifically, the article explained how fundamental indexing differentiates itself from a traditional market-cap-weighted approach, and the risks involved in tying portfolio weights directly to stock prices. By decoupling weight from price and selecting/sizing/rebalancing holdings by real-world economic scale, RAFI establishes a disciplined framework that systematically trims overextended stocks and buys underappreciated businesses. Some detractors may assume that RAFI is merely a niche value strategy. In reality, anchoring portfolio weights to economic reality redefines how portfolio allocations are constructed across the style box spectrum. This includes not only value through RAFI, but also core and growth strategies through the Research Affiliates Cap-Weighted Index (RACWI) and RAFI Growth Index (RAFIG). Research Affiliates’ fundamental methodology moves beyond traditional style-box constraints by decoupling portfolio weights from stock prices across value, core, and growth strategies. The approach redefines core allocations through the Research Affiliates Cap-Weighted Index (RACWI) by selecting companies based on economic scale to prevent costly buy-high, sell-low index additions. For growth (RAFIG) and value (RAFI) strategies, the framework eliminates value traps and speculative bubbles by measuring observable corporate expansion rather than rising price multiples. For many years, the financial industry has been categorizing equity investments according to “style box,” which was a concept developed by Morningstar. This categorization distinguishes portfolios according to the aforementioned value style box along with core/blend and growth. Following this concept, style box indexing separates companies into these categories by using price multiples (such as price-to-earnings or price-to-book) and momentum metrics. One contention with this traditional style-box methodology is that, again, it remains bound to market prices. For example, a traditional growth index simply aggregates companies with high price-to-earnings ratios and recent price appreciation, while a traditional value index selects stocks trading at low price multiples. Again, this occurs regardless of whether those low multiples reflect true bargains or severe operational distress when it comes to value. With regard to core exposure, traditional cap-weighted indexes suffer from an inherent flaw where stocks are added after substantial price run-ups and deleted after steep drops during rebalances. This can create performance drag since additions frequently underperform and nixed stocks often rebound after their deletion. As noted in a Research Affiliates article , RACWI “aims to minimize buy-high and sell-low flip-flops—companies added during a frothy fad and dropped a few short years later—a brutally costly structural flaw of traditional cap-weighted benchmarks.” Additionally, their research revealed that additions to the S&P 500 have already outpaced the market prior to their inclusion in an index, and then underperform in the subsequent year. Conversely, s...