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ETF Specialist

Active Returns With Passive Discipline

This ETF may be an index fund, but its contrarian strategy certainly isn't passive.

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Index investing has its advantages: low costs, tax efficiency, and transparency. Yet, if market prices are not always rational, it may not be ideal to weight each stock in portion to its market capitalization, as most indexes do. Blindly adopting market-cap weightings may cause investors to reduce their exposure to stocks that are trading below their fair value and increase their holdings of expensive growth stocks.  PowerShares FTSE RAFI US 1000 (PRF) is designed to address this potential problem, while retaining the benefits of a traditional index fund.

Unlike most index funds, PRF weights its holdings based on fundamental measures of size, including book value, cash flow, sales, and dividends, rather than market capitalization. Proponents of fundamental indexing argue that these metrics better capture a firm's economic footprint than does market capitalization, which can diverge from fundamental value. According to this line of reasoning, market-cap weighting tends to overweight expensive stocks and underweight cheaper names.

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.