Research Affiliates has developed a new 'Growth Index' that challenges traditional cap-weighting by selecting companies based on their percentage growth in sales, profits, and R&D.
The index weights constituents by their absolute dollar contribution to macroeconomic growth, resulting in significant holdings like NVIDIA and Apple, while excluding others like Amazon and Microsoft.
Backtested data shows the strategy would have outperformed the Russell Growth index by 4.5% annually over 30 years, and live tracking since March 2023 shows continued outperformance.
The strategy is expected to have higher volatility and turnover than traditional indexes but offers a potential solution to the market concentration and valuation risks in cap-weighted products.
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Concerns Raised
The strategy will have slightly more volatility than traditional cap-weighted indexes.
The index is expected to have 4-5 times the turnover of the S&P 500, potentially increasing trading costs.
The strategy will have occasional periods of underperformance against its benchmark.
Opportunities Identified
Significant potential for outperformance, with backtests showing a 4.5% annual excess return over the Russell Growth index.
Provides a solution to the market concentration risk inherent in cap-weighted indexes.
Offers a purer exposure to fundamentally growing companies, rather than just expensive ones.