Sample Portfolio of FTSE RAFI Funds versus Cap-Weighted ETFs

I’ve been working on modifying a spreadsheet at work that tries to backtest certain portfolios, namely fundamental indices versus cap-weighted indices versus actively managed mutual funds all in one shot and with different assumptions. Note that backtesting has its limitations though, while the numbers look good in retrospect there is no way to account for market impact, tracking error, etc.

Having Said That…

One sample that I thought I would share with you is a comparison of a portfolio of the five different mandates mentioned in the previous posts this week with the f-class management fee deducted from the annual returns for the FTSE RAFI fundamental indices and with the cap-weighted ETF MER deducted from the cap-weighted total returns. This is designed as a comparison for “fee-based” advisors who charge a separate client advisory fee so that they can see the approximate “after-management fee performance” of the two strategies. Again, I have to re-iterate that back-testing does not account for market impact and tracking error, so the real world performance difference may have been different and perhaps to a material degree. Also, this is in no way a recommendation for a portfolio allocation (though I’ve seen much worse!). :)

(You can click on the graph for a larger version)

Thanks for sticking with the blog during this week of charts and graphs. Back to some more regular posts next week… :)

Preet Banerjee
Preet Banerjee an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 8 comments
  • Scott

    Sorry I’m a bit new to this. For an individual investor, would this plot be reflected in a TSX composite ETF such as XIC vs. a TSX cap weighted index such as XIU? As a 30 year old I am interested in long term investments but don’t have the capital to diversify that much yet. Thanks.

  • Scott

    Ok I’ve done some research. No need to reply to above.

  • Brian


    These recient posts on fundamental indexing have introduced me to a whole new area of interest. Great timing, as I’m currently reading the Intelligent Asset Allocator. I wonder what William Bernstein would think of FI’s.

    Keep up the great content!

  • Jordan

    Hey Brain, I wanted to know the same thing and William Bernstein actually wrote a little article on his site about fundamental indexes that is rather pessimistic/cautious about them.

    I was personally disappointed, if he had said they were great I think I’d be 100% in to them myself.

  • Preet

    @Scott – just to be clear, XIC and XIU are both cap weighted, it’s just that one has “capping” that prevents any one security from representing more that 10% of the fund. A smaller company may still trade at inflated P/Es.

  • Preet

    @Brian – thanks for the note. There are certainly both proponents and opponents to both cap weighting and fundamental indexation.

    @Jordan – thanks for that great link. I had read it before and felt the same as you I think. Having said that, there seems to be a common misconception that RAFI is simply a value tilt – it is not. The tilt swings from value to growth and back as a result of how the metrics line up with current market conditions. I don’t know if anyone has looked at this in the frame of a three factor model, but I have some data from Research Affiliates which shows the dynamic tilt nature of RAFI – I’ll see if I can get permission to post it. Very interesting stuff.

  • Jordan

    As a follow up to my own comment, I accidentally stumbled onto another quote by William Bernstein, this time a more favorable one at the bottom of this article on Fundamental Indexes in the NY Times:

    William J. Bernstein, co-principal of the investment management firm Efficient Frontier, described fundamental investing this way: “It has higher turnover and higher transactional expenses, and so you have to be rewarded for that with extra return. And I think fundamental indexing does that.”

  • Preet

    @ Jordan – thanks again! I hope you will consider writing an article for MY blog one day… :)