FTSE/JSE RAFI 40 - So what is it?

The FTSE/JSE RAFI Index is a non-market capitalization weighted index which applies the fundamental indexationTM methodology developed by Research Affiliates LLC of Pasadena, California. The index breaks with the traditional price-based market cap weighted design, and instead derives its constituent weights from company fundamentals.

Index Construction Overview

• The FTSE/JSE RAFI 40 Index uses the FTSE/JSE All Share index as the universe.
• The four fundamental factors (Sales, Cash Flow, Book Value and Dividend) are equally weighted and will be based on the last 5 years audited values.
• The FTS/JSE RAFI 40 will take
  • Each factor's percentage as the average of available factor weights 
  • Combined weight as the average of available factor weights 
  • The RAFI fundamental value (RFV) is the composite weight X 10 million 
• The 40 companies with the largest RFV are the index constituents. 
• Constituent weight in the index is based on the RFV of the company and will be capped at 10%.
• The constituents may differ from the constituents in the FTSE/JSE Top 40 Index.

Features:

• The FTSE/JSE RAFI 40 offers a quantitative active management strategy with the highlights of passive market cap based indexing.
• By using fundamental factors rather than prices to weight constituents, reviews of the FTSE/JSE RAFI 40 Index take advantage of price movements by reducing the index’s holdings in constituents whose prices have risen relative to other constituents, and increasing holdings in companies whose prices have fallen behind. This is effectively a buy-low, sell-high strategy
• Fundamentals weighting does not increase exposure to high P/E equities during episodes of unsustainable P/E expansion. It therefore avoids over-exposure to the more overvalued equities
• Similar liquidity and capacity to market cap-weighted indices
• Superior mean-variance portfolio construction
• A diversified index in company and sector terms