The bedrock measures are rebalanced annually, but the enhancements rely on fresh data and are hence rebalanced quarterly. Despite their record of outperformance, Arnott said he was not surprised that no fund had replaced its capweighted core. “If you’re managing a large pool of money, there are limits to how far you can stray away from convention. It’s sometimes referred to as maverick risk. Most people don’t want to take on enough maverick risk that an idea or strategy would be abandoned in one bad year.

So even those who view fundamental indexing as “better beta” are likely to want to have diversified beta”. However he takes consolation from the fact it took “about fifteen years” from the introduction of a Standard & Poor’s cap-weighted index of US stocks in 1957 for any money to actually be managed on it, and “another fifteen years before the amount of money that’s fundamentally indexed today was managed on a cap-weighted basis”. There is US$20 billion fundamentally indexed globally today (out of a total market cap of US$40 trillion) but Arnott said he would be “stunned” if there was not US$30 billion in RAFI strategies by the time 2009 was out.

FTSE is doing its bit for the growth of the strategy in Australia, with the first Australian FTSE/RAFI indices about to become available for implementation. As the concept grows in popularity, it has also become cheaper, for instance Invesco Powershares recently dropped prices on its range of FTSA/RAFI exchange traded funds from 60 bps to 39 bps, once assets under management surpassed US$1 billion.

Arnott accepts that fundamental indexing remains more expensive than cap-weighted indexing. He estimated the RAFI range is priced anywhere from “half to one-third” of the equivalent active strategy, while cap-weighted indexing is more like one-tenth. But he says the gap is closing. “I was in a debate with [Vanguard founder and trenchant critic of fundamental indexing] Jack Bogle last fall, and he was saying ‘your strategies are so expensive’. I turned to him and said ‘Jack, when you first launched your S&P 500 index fund did you charge seven basis points?’ Discussion over.”         

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