Rob Arnott on New ETF (RAUS) and the Future of Passive Investing

The Achilles Heel of Cap-Weighted Indexing

• 💡 Conventional cap-weighted indexes, while passive, have an "Achilles heel" due to significant annual turnover (4-5%).
• 🎯 This turnover often involves buying stocks at inflated multiples (twice the market average) and selling unloved stocks at low multiples, chasing a "frothy emerging growth strategy."
• ⚠️ This "flip-flop" strategy, where promising stocks are added and then later fall out of the index, can cause substantial damage to returns.

Introducing the Research Affiliates ETF (RAUS)

• 🚀 The new Research Affiliates Cap-Weighted US ETF (RAUS) aims to address this by adding patience to the indexing strategy.
• 🔑 The core change is to add stocks to the index when their business is large enough to matter and sell them when they are no longer significant.
• 📈 This simple adjustment lowers turnover, making the strategy more passive than traditional cap-weighted indexes, and historically boosted returns by 69 basis points per annum with about 1% tracking error.

Passive vs. Active Management Clarified

• 🧩 While RAUS tracks an index, it is not actively managed; it is as passive as the Russell 1000 and has lower turnover than the S&P 500.
• 🔍 The value comes from avoiding fads, bubbles, and selling stocks when they are out of favor, rather than active stock picking.
• 📊 RAUS has 95% overlap with the S&P 500, with differences at the margins, focusing on businesses that are consistently large enough to matter.

The Dillard's Example and Market Cycles

• 🎭 The case of Dillard's department store is highlighted: it has been in and out of the S&P 500 five times in 30 years, illustrating a "buy high, sell low" pattern.
• 💰 Owning Dillard's when it was not in the index for 13 years yielded a 67x return, while owning it when it was in the index for 23 years resulted in a near 100% loss.
• 📉 This demonstrates how market timing within index inclusion/exclusion can dramatically impact wealth, a phenomenon more pronounced at the large-cap end.

Fee Structure and Long-Term Vision

• 💰 RAUS is priced at zero for the first year, a strategy aimed at achieving scale and attracting significant assets under management.
• ⏳ Arnott emphasizes a long-term vision, stating he doesn't care if the ETF is a big money-maker in 5 years, but is focused on creating a revolution in indexing that will succeed over 10 years.
• 🚫 He also touches on the issue of short-termism in public markets, preferring less regulatory distraction and more freedom for companies to report on their own timelines.