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An Enhanced Value Strategy Gives This ETF an Edge

Rather than using a market-cap-weighted approach, PowerShares FTSE RAFI US 1000 introduces a value tilt by weighting companies based on fundamental measures.

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Alex Bryan: PowerShares FTSE RAFI US 1000 ETF (PRF) offers a distinctive value strategy. It invests in a broad swath of large- and mid-cap U.S. stocks. However, rather than weighting them by market capitalization as most index funds do, it assigns weightings according to fundamental measures of size, including sales, cash flow, book value, and dividends (where applicable). This introduces a value tilt in two ways: First, it causes the fund to overweight stocks that are trading at low multiples with these metrics and underweight more expensive stocks relative to a market-cap-weighted benchmark.

Secondly, fundamental weighting causes the fund to increase its exposure to stocks that have become cheaper relative to their peers when it rebalances and trim back on positions that have become more expensive. These disciplined bets against the market may help the fund more effectively profit from mean reversion in valuations than market-cap-weighted value funds. However, they can also increase its exposure to stocks with deteriorating fundamentals because accounting metrics are usually slower to pick up on that than market prices.

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