Research affiliates

What Is Research Affiliates?

Research Affiliates is a global investment management firm that specializes in developing innovative and research-driven investment strategies.⁶⁶ Founded in 2002 by Rob Arnott, the firm is a prominent figure in the realm of [Investment Management], particularly known for its pioneering work in smart beta and factor investing approaches.⁶⁴, ⁶⁵ Research Affiliates aims to challenge conventional wisdom in the financial industry by focusing on systematic investment strategies that seek to deliver improved performance for investors.⁶³ Their methodologies are often licensed to other asset managers, making their influence widespread across various investment products like mutual funds and [Exchange-Traded Funds (ETFs)].⁶² The firm emphasizes rigorous [quantitative analysis] and a long-term perspective in its approach to [portfolio management] and [asset allocation].⁶¹

History and Origin

Research Affiliates was established in 2002 by Robert D. Arnott, a respected figure in quantitative finance.⁵⁹, ⁶⁰ Prior to founding Research Affiliates, Arnott had a distinguished career, including serving as chairman of First Quadrant and global equity strategist at Salomon Brothers.⁵⁸ His vision for Research Affiliates was to create a research-intensive firm dedicated to developing "non-traditional" investment strategies.⁵⁷

One of Research Affiliates' most significant contributions is the development of the "Fundamental Index™" (RAFI™) approach to investing. Thi⁵⁶s methodology challenges traditional market-capitalization-weighted indexing by weighting securities based on fundamental measures of company size, such as sales, earnings, book value, and dividends, rather than solely on market price. Arn⁵⁴, ⁵⁵ott and his colleagues introduced this concept to address what they identified as inherent biases in cap-weighted indices, which can overemphasize overvalued stocks and underemphasize undervalued ones. Thi⁵³s innovation laid foundational groundwork for the broader adoption of [factor investing] and smart beta strategies across the investment landscape.

##⁵² Key Takeaways

• Research Affiliates is an investment management firm founded by Rob Arnott in 2002, known for its research-driven, systematic investment strategies.
• ⁵¹ The firm is a pioneer in smart beta and factor investing, most notably with its "Fundamental Index" (RAFI) methodology, which weights stocks by fundamental metrics instead of market capitalization.
• ⁴⁹, ⁵⁰ Research Affiliates licenses its innovative strategies to other leading asset managers, influencing a wide range of investment products globally.
• Their work challenges traditional [passive investing] by seeking to capture specific risk premia and enhance long-term, risk-adjusted returns.
• ⁴⁸ The firm places a strong emphasis on academic rigor and research, publishing numerous papers on investment theory and practical applications.

##⁴⁶, ⁴⁷ Interpreting Research Affiliates' Approach

Research Affiliates' investment philosophy is rooted in the belief that market prices are not perfectly efficient, and that systematic, rules-based strategies can exploit these inefficiencies to generate improved investment performance. The⁴⁵ir flagship Fundamental Index approach, for instance, implies that by weighting companies based on economic footprint (e.g., sales, profits, book value) rather than market price, a portfolio can inherently tilt towards [value investing] and away from potentially overvalued segments of the market. Thi⁴³, ⁴⁴s dynamic rebalancing mechanism means that as certain companies become overvalued relative to their fundamentals, their weight in a Fundamental Index would naturally decrease, and vice-versa for undervalued companies.

In⁴¹, ⁴²vestors interpret Research Affiliates' strategies as a way to gain diversified exposure to markets while also seeking to capture [alpha] from known factors or behavioral anomalies. Unl⁴⁰ike purely [active management] strategies that rely heavily on discretionary stock picking, Research Affiliates' methodologies are systematic and transparent, applying predetermined rules. This provides a middle ground between traditional [index funds] and high-conviction active strategies, appealing to [institutional investors] and individual investors alike who seek a structured yet potentially performance-enhancing approach.

##³⁸, ³⁹ Hypothetical Example

Consider an investor, Sarah, who traditionally invested in a market-capitalization-weighted S&P 500 index fund. She observes that while this fund offers broad [diversification], it tends to concentrate heavily in the largest, often most popular companies. Inspired by the principles of Research Affiliates' Fundamental Indexing, Sarah decides to explore a hypothetical "Fundamental 500" index that weights companies based on their five-year average sales, book value, and dividends, instead of market cap.

Suppose in this hypothetical scenario, Company A has a market capitalization of $1 trillion but relatively modest sales and profits, while Company B has a market capitalization of $500 billion but significantly higher sales and profits over the last five years. In a cap-weighted index, Company A would have twice the weight of Company B. However, in Sarah's hypothetical Fundamental 500, Company B might receive a larger weight than Company A due to its stronger fundamental metrics, even though its market cap is lower. If Company A's stock price subsequently declines because its fundamentals don't support its high valuation, Sarah's fundamental-weighted portfolio would be less exposed to this decline compared to a cap-weighted index. Conversely, if Company B, despite its strong fundamentals, was undervalued by the market, the fundamental-weighted index would overweight it, potentially benefiting from its future appreciation. This approach implicitly incorporates a systematic [rebalancing] to maintain exposure to fundamentally sound companies, regardless of short-term market fluctuations.

Practical Applications

Research Affiliates' strategies are widely applied across the financial industry, primarily through partnerships and licensing agreements with major asset managers. Their methodologies are frequently used to construct [ETFs] and mutual funds that cater to both institutional and individual investors.

Ke³⁷y applications include:

• Smart Beta ETFs: Many smart beta ETFs utilize Research Affiliates' Fundamental Index methodology or similar factor-based weighting schemes, providing investors with exposures to factors like value, size, momentum, and low volatility in a rules-based, transparent, and often cost-effective manner. For³⁵, ³⁶ example, their strategies are used within funds that aim to achieve targeted outcomes by tilting portfolios toward specific drivers of risk and return.
• ³⁴ Institutional Portfolios: Pension funds, endowments, and other large [institutional investors] integrate Research Affiliates' strategies into their broader [asset allocation] frameworks. The³³se strategies can serve as core equity allocations or as complementary satellite holdings designed to enhance returns or manage [risk management] more effectively. The³² adoption of smart beta strategies, often pioneered by firms like Research Affiliates, has grown significantly among institutional investors over the past decade.
• ³⁰, ³¹ Custom Indexing: Research Affiliates also works with clients to develop customized indices and portfolio solutions tailored to specific investment objectives, going beyond standard market-cap-weighted benchmarks.
• ²⁹ Quantitative Active Equity: Beyond indexation, Research Affiliates applies its quantitative analysis capabilities to manage active equity strategies, seeking to identify and exploit mispricings in the market systematically.

Th²⁸e continued growth of smart beta and factor investing underscores the practical impact of firms like Research Affiliates, offering investors alternative systematic [investment strategies].

##²⁷ Limitations and Criticisms

While Research Affiliates and its smart beta approaches offer potential benefits, they are not without limitations and criticisms. A primary critique, particularly of fundamental indexing, is that it may largely be a repackaging of a [value investing] strategy rather than a fundamentally new source of alpha. Cri²⁵, ²⁶tics argue that the outperformance observed from such strategies can often be attributed to their inherent tilt towards value and smaller-cap stocks, which have historically shown periods of outperformance, but also extended periods of underperformance.

An²³, ²⁴other concern is the potential for "factor crowding" where too much capital flows into popular smart beta strategies, potentially diluting future returns. As ²²more investors chase historically successful factors, the premiums associated with those factors could diminish. Research Affiliates itself has cautioned against performance chasing in smart beta, noting that strong past returns might be due to rising valuations rather than persistent structural alpha. Thi²¹s could lead to a "smart beta crash" if popular factors revert to their mean.

Fu¹⁹, ²⁰rthermore, the "rules-based" nature of smart beta, while offering transparency, can still be complex. Understanding the specific [factor investing] exposures and how they interact can be challenging for some investors, and the strategies may not always align perfectly with an investor's desired outcome, especially over shorter time horizons. The¹⁷, ¹⁸ transaction costs associated with rebalancing a fundamentally weighted index, though generally low, are also a consideration when evaluating net returns.

##¹⁶ Research Affiliates vs. Smart Beta

The terms "Research Affiliates" and "[Smart Beta]" are related but distinct. Research Affiliates is a specific asset management firm and research house, co-founded by Rob Arnott. It is an entity that develops and licenses investment methodologies.

Sm¹⁴, ¹⁵art Beta, on the other hand, is a broad category or investment approach that refers to systematic, rules-based investment strategies that do not rely solely on market capitalization weighting. The¹³se strategies aim to achieve specific investment objectives, such as enhancing returns or reducing risk, by tilting a portfolio towards certain factors (e.g., value, size, momentum, quality, low volatility).

Re¹²search Affiliates is a pioneer and a leading proponent of smart beta. Their Fundamental Index™ (RAFI™) approach is one of the most well-known and influential smart beta methodologies. Therefo¹⁰, ¹¹re, while all strategies developed by Research Affiliates within this domain can be categorized as smart beta, not all smart beta strategies originate from or are associated with Research Affiliates. The firm plays a significant role in defining and advancing the smart beta landscape, but the concept itself encompasses a wider range of alternative indexing methods from various providers.

FAQ⁹s

What kind of assets does Research Affiliates manage?

Research Affiliates develops a range of investment strategies, primarily focusing on smart beta, enhanced indexing, quantitative active equity, and multi-asset solutions. While they develop the strategies, they often license their methodologies to other investment managers who then manage funds and ETFs using these approaches.

Ho⁸w does Research Affiliates' Fundamental Index differ from traditional indexing?

Traditional indexing, like the S&P 500, weights stocks based on their market capitalization (price multiplied by shares outstanding). Research Affiliates' Fundamental Index methodology instead weights companies based on fundamental measures of their economic size, such as sales, earnings, book value, and dividends, typically averaged over several years. This ai⁶, ⁷ms to avoid overvaluing companies based solely on their stock price and provide a consistent tilt toward fundamental value.

Is⁵ Research Affiliates considered an active or passive manager?

Research Affiliates' strategies blend elements of both [active management] and [passive investing]. While their Fundamental Index strategies are rules-based and aim to replicate an index (a characteristic of passive investing), the index itself is constructed using criteria that seek to outperform traditional market-cap-weighted benchmarks, which is an active goal. This positioning is why these strategies are often referred to as "smart beta" or "strategic beta," sitting between purely active and passive approaches.

Wh³, ⁴at is the primary goal of Research Affiliates' investment strategies?

The primary goal of Research Affiliates' investment strategies is to generate improved [risk-adjusted returns] for investors over the long term by systematically capturing specific risk premia or correcting for market inefficiencies. They aim to provide alternative and potentially more effective ways to gain market exposure than traditional capitalization-weighted indices.

Do²es Research Affiliates offer direct investment products?

Research Affiliates primarily acts as a research and intellectual property firm, licensing its investment methodologies to other asset management companies. These partners then create and manage specific investment products, such as mutual funds and [ETFs], that implement Research Affiliates' strategies.¹