Table Summary for Large Cap The fundamental index fund (PRF) beat out handsomely the other benchmarks over the entire period by 2.3 to 5.1 percentage points in annual return. But, it did it by fairing poorly in the 2007 Crash and extraordinarily well in the 2009 Recovery. Level of risk (daily volatility) is similar.
Large Cap: Back Testing vs Actual The relative performance of the RAFI large cap was very different during the two periods . While in the 45 years of back testing, it excelled at besting the S&P 500 in Bear markets while recording only a small advantage in Bull markets; in the actual 4.25 years it faired poorly in the Crash of 2007. But, did extremely well in the Recovery of 2009.
Small Cap indexes correlation Fundamental index (PRFZ) correlation to value index or regular ones are equally high.
Table Summary for Small Cap The fundamental index fund (PRFZ) beat out the other benchmarks over the entire period by 7.2 to 8.0 percentage points in annual return. But, it did it by fairing poorly in the Crash and extraordinarily well in Recovery. PRFZ bears similar level of risk.
Small Cap: Back Testing vs Actuals The relative performance of the RAFI small cap was very different during the two periods . While in the 28 years of back testing, it excelled at besting the Russell 2000 in Bear markets while recording a smaller advantage in Bull markets; in the actual 3.5 years it faired poorly in the Crash of 2007. But, did extremely well in the Recovery of 2009.
Why did the RAFI U.S. 1000 Large Cap did poorly in the Crash of 2007?
Why did the same fund do so much better than its counterparts in the Recovery of 2009?
Explanation for poor performance in 2007 Crash: Growth vs Value…
Large Value oriented index funds (including the RAFI funds) performed worse than traditional index funds during the Crash of 2007.
Investigating the performance of a growth index fund vs a value index one may be interesting. Let’s look at Vanguard Growth Index (VIGRX) and Vanguard Value Index (VIVAX) that have long historical data going back to 1993.
The Dot.com bust A Value index being less exposed to the hi-tech sector with high P/E ratio performed much better than a Growth index.
The 2007 Credit Crash Now, the Value index performed marginally worse. This credit crisis emerged from the financial sector (banks, insurance) that is more prevalent within a Value index including the RAFI US 1000 fund.
Why did RAFI US 1000 do well in Recovery? Let’s look at sector allocations
3 key sector allocation differences and performances during the recovery RAFI US 1000 is more heavily invested in Financials that did extremely well and less invested in Energy and Healthcare that did not do as well.
The RAFI 1000 Large cap performed poorly during the 2007 Credit Crisis because of its large exposure to Financials. This same exposure to Financials caused it to fare extremely well in the 2009 Recovery.
Investing in the RAFI 1000 Large cap may entail chronic sector bets including being overweighed in Financials (low P/E sector) and underweighed in Hi tech (high P/E). Such a fund will do well in any hi-tech bubble burst, but not so well in any financial/credit crisis.
The RAFI 1000 Large cap has a steadier sector allocation than its market cap counterparts because it prevents specific sectors from bubbling.
So far, there seems to be more than just a Value orientation to such funds.
A longer actual record will prove informative in fully assessing the relative performance of RAFI funds.