EDZ - Russell RAFI Index Review Shines Spotlight On Emerging Markets
2023-07-14 03:10:00 ET
Summary
- RAFI Emerging Markets Large Company Index outperforms due to market volatility and emphasis on value-oriented companies.
- Combining different index approaches can help investors achieve their risk and return objectives.
- Index methodology plays a crucial role in constructing and understanding index performance.
By Catherine Yoshimoto, director, product management
Each year in March, we conduct a review of our Russell RAFI™ Index Series , which is designed to capture the beta of a fundamentally weighted - as opposed to a traditional market cap weighted - index strategy.
We calculate security-level fundamental weights at this time, and ensure the indexes reflect planned additions and deletions in the FTSE Global Total Cap Index , as well as any country or classification changes. We then implement the constituent stock weight changes with a staggered approach across four quarters.
This year’s annual review resulted in several changes across our Russell RAFI Indexes - and the most noteworthy were in the Russell RAFI Emerging Markets Large Company Index .
What it means to be a fundamental index
For traditional indexes such as our Russell US Indexes, constituent weights are based on market capitalization. Fundamentally weighted indexes, however, assign weights based on company fundamentals - effectively breaking the link between a company’s stock price and index weight.
For our fundamentally weighted Russell RAFI Indexes, we use the FTSE Global Total Cap Index as a starting universe and take the average of three fundamental measures to calculate constituent weights: adjusted sales, retained operating cash flow, and dividends plus buybacks.
Additionally, the annual review of the Russell RAFI Index Series is implemented across the year rather than at one point in time to help increase investment capacity and minimize entry point risk.
While these two distinct constituent weighting approaches can result in different index composition and performance outcomes, both types of indexes are constructed with transparent, objective, and rules-based methodologies.
A story of market cap growth for large company indexes
The outcome of our 2023 Russell RAFI Index Series review is a story of net market cap growth for large company indexes. As shown, US, Developed ex US, and Emerging Markets large company indexes increased in net market cap as a result of the review.
The US and Emerging Markets indexes also grew in number of constituents, with notably more significant changes across the board in the Emerging Markets Index.
Fundamentally weighted Emerging Markets outperform
Just as we do when we reconstitute our Russell US Indexes each June, we can also use our annual RAFI Index review as an occasion to look back on how the indexes have fared over the past year.
When comparing our Russell RAFI Indexes with their market cap weighted counterparts, we can observe that the Russell RAFI Emerging Markets Large Company Index had the strongest relative performance since the March 2022 index review.
RAFI Emerging Markets Large Company Index outperformance can perhaps be attributed to the volatility that roiled markets in 2022. As fundamentally weighted index constituents are less dependent on stock price, they tend to emphasize more value-oriented companies, which are generally rewarded more in times of heightened global market volatility.
This effect can be enhanced in traditionally more volatile and price sensitive global regions such as emerging markets.
Two complementary index approaches
Indexes that are constructed differently from a standard cap weighted index will likely perform differently in various market environments, so it’s important not to put too much emphasis on which index methodology outperforms the other for any given time period.
Our Russell RAFI Index Series is designed to complement traditional market cap weighted indexes, where a blend of the two approaches can help investors meet risk and return objectives over time.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Russell RAFI Index Review Shines Spotlight On Emerging Markets