THOUGHT LEADERSHIP

A Decade of Results

The Past, Present and Future of Fundamental Index Strategies

It’s been 10 years since Charles Schwab Investment Management, Inc. first launched the Schwab Fundamental Index Funds* that are designed to track indexes that utilize the Research Affiliates Fundamental Index™ (RAFI™) methodology. As one of the first providers of what is now a staple among the wide range of strategic beta offerings, the Schwab Fundamental Index mutual funds and ETFs provide investors with a unique way to access the market, as well as offer the potential for excess returns versus market cap index products.

Not all strategies are created equally
The RAFI indexes were launched to offer a systematic way to avoid the biases of traditional market cap indexes by removing the arbitrary measure of market price from the equation. Instead, the Fundamental Index strategies weight companies based on more objective, economically based measures to determine the index weighting methodology. Using fundamental measures such as retained operating cash flow, adjusted sales, and dividends plus buybacks allows the strategies to remove the potential biases of an active manager who may favor a particular stock because of past performance or emotional attachment. This disciplined rules-based approach weights securities by objective fundamental measures, and minimizes the impact of excessive stock valuations through periodic rebalancing.

The benefits of the Fundamental Index approach
The Schwab Fundamental Index products offer the potential for outperformance relative to market cap index products over time while retaining many of the benefits of index investing, such as broad diversification to equity exposure and generally lower expenses as compared to actively managed funds.

 

A decade of outperformance
Although Fundamental Index strategies have experienced short-term periods of underperformance, the last 10 years demonstrate the value a Fundamental Index strategy can provide to a portfolio over the long term. Since April 1, 2007, the Fundamental Index strategies outperformed market cap indexes in each of the five major equity market segments, by a measure that ranged from 50 to 220 basis points per year.1

Generating excess returns during a period of underperformance for value relative to growth underscores the power of Fundamental Index strategies. Fundamental Index strategies have historically been able to deliver excess returns by breaking the link with price, weighting securities based on fundamental measures, and then rebalancing over time. These contrarian strategies are designed to avoid overweighting securities based on their size or popularity. They exhibit a dynamic value tilt. The degree of the value tilt will vary over time depending on the relative valuation of the underlying securities. This dynamic nature of the strategies’ value tilt is what allowed them to outperform during a decade that was predominantly challenging for value strategies.

Over the 10-year period, the Fundamental Index U.S. Large strategy outperformed the market cap Russell 1000 Index while the international and emerging market strategies also outperformed their market cap index equivalent, providing value during an era that included the Great Recession, the Taper Tantrum and the monumental Brexit vote.2 We know that when markets get volatile, investors often move to the sidelines and then miss out on the subsequent recovery. Investors who remained invested in Schwab Fundamental Index mutual funds through the peaks and valleys of the past 10 years would have realized the benefits of this rules-based approach, with the large majority of mutual funds delivering meaningful excess returns compared to their market cap equivalents.

Looking ahead 
With a decade of performance across various market environments, the Fundamental Index strategies have been battle tested and delivered value-add even through challenging times. By breaking the link between price and weight they avoid overweighting overvalued companies and underweighting undervalued companies. This creates an opportunity to generate excess returns, as the portfolios rebalance away from market swings and are positioned to capture upside when mean reversion occurs.

As our confidence continues in the Fundamental Index methodology, we believe Schwab Fundamental Index mutual funds and ETFs could be well positioned to continue to add value. It’s hard to argue against the importance of strategic beta products in portfolio building, and we believe Fundamental Index products are poised to become an even more integral part of a diversified portfolio.

 To learn more about Schwab Fundamental Index Funds, visit schwabfunds.com/fundamental


For institutional investor use only. 
Investors should consider carefully information contained in the prospectus, or if available, the summary prospectus, including investment objectives, risks, charges and expenses. You can view and download a prospectus by visiting www.schwabfunds.com. Please read the prospectus carefully before investing.
Past performance does not guarantee future returns.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. 
There can be no assurance that the Fundamental Index methodologies will achieve their desired outcomes. Each investing strategy involves its own set of unique risks and benefits. Shares of ETFs are bought and sold at market price, which may be higher or lower than the net asset value (NAV). 
*Schwab is a registered trademark of Charles Schwab & Co., Inc. (Schwab). “Research Affiliates®”, “Fundamental Index®” and “RAFI®” trade names are the exclusive property of Research Affiliates, LLC. 
Not all Schwab Fundamental Index mutual funds have a 10 year history. The Schwab Fundamental Index ETFs launched August 15, 2013. For a list of all Schwab Fundamental Index funds, please visit www.schwabfunds.com.  
For a list of Fundamental Index strategy definitions, please visit www.schwabfunds.com/RAFIindexes  
Charles Schwab Investment Management is the investment adviser for Schwab Funds and Schwab ETFs. Schwab Funds are distributed by Charles Schwab & Co., Inc. (Schwab), Member SIPC. Schwab ETFs are distributed by SEI Investments Distribution Co. (SIDCO). CSIM and Schwab are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation, and are not affiliated with SIDCO. 
Information and data provided have been obtained from sources deemed reliable, but are not guaranteed.
1Data Source: Research Affiliates LLC (RA) as of 3/31/2017
2Data Source: Morningstar Direct

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