You are not viewing the content in your capacity as a retail investor for the purposes of section 761G of the Corporations Act 2001; 
Investment philosophy & process
Realindex investment philosophy
The Realindex Funds use the Fundamental Index methodology in the construction of its portfolios. This approach is based on the belief that markets are not perfectly efficient and that pricing errors can lead to a performance drag for traditional market cap–weighted index funds.
The belief that markets are not perfectly efficient assumes the stock price of a firm is not exactly equal to its true fair value at every moment in time. This in turn means that a cap–weighted approach will systematically overweight firms that are overvalued and underweight firms that are undervalued. Following the principles of this methodology, the Realindex Funds operate on the assumption that as markets tend to move towards true fair value stock prices, overvalued firms will experience relatively lower returns and undervalued firms will experience relatively higher returns. On aggregate, based on this assumption, this means cap–weighted index funds that are systematically misallocated to over– and undervalued securities will suffer a performance drag.
In Realindex funds, stocks are selected and weighted using fundamental measures of firm size, including cash flow, sales, book value and dividends. The Realindex funds aim to enhance this process by adding factors such as quality of earnings and debt coverage. In addition, the weights are adjusted periodically throughout the year rather than once per year.
By weighting on fundamental measures of size instead of market capitalisation, the RAFI method seeks to avoid potential systematic overweighting of overvalued stocks and underweighting of undervalued stocks. Therefore, it aims to avoid the return drag that may be experienced by a traditional cap–weighted portfolio. Nevertheless, the RAFI methodology aims to retain what we believe are the major advantages of traditional index–based portfolios.
The methodology used to select the enhanced RAFI portfolio of companies is designed not to favour either value or growth companies relative to their economic scale and pays no direct regard to valuation multiples or price.
Fundamental measures
The Realindex Funds combine four individual fundamental measures of a company’s economic size to create a portfolio:
- Sales: Company sales averaged over the prior five years.
- Cash flow: Company cash flow averaged over the prior five years.
- Book value: Latest company book value as at the review date.
- Dividends: Total dividend distributions averaged over the prior five years, including special dividends paid in cash. For companies that have never paid dividends, the portfolio weight is re–calculated based on the other three metrics.
Realindex portfolios include additional factors such as quality of earnings and debt coverage, as well as quarterly rebalancing.
The methodology seeks to eliminate the link between portfolio weight and any over– or under–valuation associated with weighting a portfolio by market capitalisation, with the aim of randomising the weighting errors and reducing the associated performance drag. The RAFI methodology weights the size metrics to reflect the economic footprint of a company.
The original research into the methodology was conducted in the US market by Research Affiliates and published in the Financial Analysts Journal in 2005. The paper is available from the Research Affiliates website.