Investment Management has had its suite of fundamental index mutual funds since 2007, but the firm is now taking the concept to the ETF market, with its launch today of six ETFs based on fundamental indexes.
The funds will track the Russell Fundamental indicies, based on the fundamental weighting of securities, a concept developed by Research Affiliates’ Rob Arnott. Rather than weighting companies by traditional market capitalization—with the largest companies having the largest weights—these funds will weight securities on economic factors, including adjusted sales, retained operating cash flow and dividends plus buybacks.
“Because traditional market cap indexing overemphasizes popular stocks and deemphasizes undervalued stocks, some experts believe it can overexpose investors’ portfolios to market speculation and bubbles,” said Marie Chandoha, president of CSIM, on a conference call with reporters.
Chandoha said 59 percent of Schwab'sclients use fundamentally weighted index strategies, and one in five said they plan to use more of these in the near future.
The new funds include: Schwab Fundamental U.S. Broad Market Index ETF (FNDB); Schwab Fundamental U.S. Large Company Index ETF (FNDX); Schwab Fundamental U.S. Small Company Index ETF (FNDA); Schwab Fundamental International Large Company Index ETF (FNDF); Schwab Fundamental International Small Company Index ETF (FNDC); and Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE). They will start trading commission-free on Aug. 15.
The firm provided an example of how the concept works: Through the first three quarters of last year, Apple’s stock was up 65 percent and had the largest weighting in the Russell 1000 Index, with a 4 percent weighting at its peak.
“As analysts began to question the merits of Apple and their growth prospects, Apple has fallen nearly 40 percent since that period of time,” said Tony Davidow, vice president of alternative beta and asset allocation strategist for the Schwab Center for Financial Research.
Not a good thing for Russell 1000 investors. Over that same time period, the Russell Fundamental Index outperformed the Russell 1000 by over 400 basis points, Davidow said. And while Apple had the second largest weighting in the index at the end of the second quarter, the computer company was the 70th largest name in the Russell Fundamental U.S. Large Company Index.
“Market-cap indicies by comparison tend to have a larger cap bias and may also exhibit a growth bias over time,” Davidow said. “They’re also prone to boom and bust periods.”