RAFI Corrects Statements On EM Index Backtests

Last Updated: 21 March 2023

Research Affiliates, creator of the “fundamental index” series of equity benchmarks, has corrected earlier statements about back-tests made by its founder, Rob Arnott, in a recent interview with IndexUniverse.eu.

According to Arnott, a historical simulation of fundamental indexation in emerging markets suggests the method can add up to 8 percent a year in additional performance against a standard capitalisation-weighted index.

Fundamental indexation attaches weightings to companies in an equity index according to several fundamental accounting measures: sales, earnings, book value, cash flow and dividends.

In an earlier article on this site, contributor Cris Heaton had questioned whether the promises of substantial outperformance made by the promoters of fundamental indices might hold true in practice.

“There are reasons to expect any value added by fundamental indexation in future to be smaller than a back-test might imply,” Heaton wrote, suggesting that special factors, including a lack of free float adjustments, may have flattered indices’ back-tested performance.

The free floats of emerging market equities are often limited to a small percentage of companies’ stated share capital as a result of major state shareholdings or other controlling interests.

Adjusting companies’ weightings in equity indices for free float has been standard practice amongst major index providers for well over a decade.

Free float adjustment became particularly topical during the late nineties dot.com boom, when it became apparent that the demand from index-tracking fund mandates for the shares of newly listed companies could easily exceed the number of shares floated, causing temporary price distortions. The free float method is now widely used.

However, there is still no standard practice in this area, particularly in less-developed share markets. And even in developed markets, where index providers adjust for free float as a matter of course, index rules and those of listing venues are not always aligned.

For example, last year FTSE raised its minimum free float requirements for UK-listed shares, specifying that at least 25 percent of a company’s equity must be freely traded.

The move meant FTSE was imposing stricter liquidity standards than the UK Listing Authority (UKLA), which is part of the UK’s national securities market regulator, the Financial Services Authority.

In recent years the UKLA has often been willing to waive its standard 25 percent free float requirement for larger foreign companies willing to reincorporate in the UK.

In his March 8 interview with IndexUniverse.eu, Research Affiliates’ founder, Rob Arnott, stated that Research Affiliates’ emerging market equity index back-tests had included an adjustment for free float.

Following additional questions from IndexUniverse.eu, Arnott corrected his earlier statement, saying that the stated history of Research Affiliates’ emerging markets index had not included a float adjustment prior to 2007.

“Our FTSE RAFI Emerging Markets (EM) index was launched in July 2007,” Arnott said in an e-mailed response.

“The simulation was performed without float adjustments.  Because historical data on float is near-impossible to track down after the fact, we never changed the FTSE RAFI EM history to reflect float adjustments. For what it’s worth, all the major index providers (S&P Dow Jones, MSCI, FTSE) publish back-tested, simulated results without float adjusting.  So we’re not alone in this regard.”


  • Luke Handt

    Hello, my name is Luke Handt; I am a successful Bitcoin trader, financial analyst, and researcher. I have been studying the market trends for the conventional stock exchange system globally since I was in college.

error: Alert: Content is protected !!