The central thesis of Fundamental Indexing is that weighting the components of an index by their “economic footprint” allows the portfolio to avoid some of the deficiencies of a capitalization weighted index, such as over-weighting of overvalued stocks and under- weighting of undervalued stocks. In this paper, we argue that the recent outperformance of RAFI over that of traditional cap-weighted indices has not been a result of the strategy’s ability to arbitrage the inefficiency of cap-weighted indexing, but a reward from loading on factor tilts – namely the size and value “risk” factors. The size and value factors has.
