Three Alternatvies of Indexing

(1/28/2006)

In the last few days, I was thinking about adding PRF (Powershares FTSE RAFI US 1000 Index Fund) to my portfolio.

I first discovered similar concept with the Fortune 500 index fund, which include 500 companies with the largest revenues. However, the index still used the market capitalization as the weighting factor.

When PRF was first announced several months ago, I got very interested in the concept. Over the past few days, I have researched online all the related information about the PRF fund and its associated index. I feel this is a great alternative to the currently dominant S&P 500 indexing methodology.

Now I have investments in all three alternatives.One is the market-cap weighted methodology. Several main index families use this method. S&P 500 index, Russell 1000, or Wilshire 5000 all use this method. Most of these index funds are the traditional ones. I can find them almost all in Vanguard funds. One can also have similar investment with SPY.

The second alternative is the S&P 500 equal weight index fund RSP. I have investments in this one for a while already. I really like RSP because it rebalances its components every quarter. This way, the buy low sell high principle is used four times in a year. Another benefit is the equal weight favors the smaller components in the S&P 500 index.

Now there is the third alternative PRF. This index fund completely does away with the market capitalization weight. It uses four economic parameters to weigh its components. The four parameters it use are sales revenues, cash flows, book values, and dividends. Each contributes the same weight. The original thinker in this methodology is Research Affiliates LLC. It calls the RAFI index as the main street index while it calls the S&P 500 index as the Wall street index.

I believe all three alternatives have their own merits. So one should invest in all three funds: SPY, RSP, and PRF. This way one can avoid the disadvantage of each one of them.

Chapter O Introduction to Metabraid

Over the last several years, I have developed an investment methodology for investing in mutual funds, including open-end mutual funds, closed-end mutual funds, and ETF (exchange-traded funds). This method is to invest in a wide collections of mutual funds to achieve an overall return which is very close to the average market return with a reduced risk level.

The original idea came from reading a financial book about the investment frontier curve. In this curve, the investment return and investment risk are inversely related to each other. The higher return is usually associated with higher risks. I was thinking about to take the advantage of asset classes with different risks by combing in one portfolio with all the available asset classes.

Later I discovered that this methodolgoy of combing many different asset classes into one portfolio had been used by institutional investors to manage their large assets already. By combing asset classes with different risks and different correlation coefficients, one can create a portofolio which can stand all the girations of each classes of assets but with a stable asset value for the overall asset.

I call this kind of investing method as metabraid. I have learned the word braid from three occations. One is that some women braid their hairs as braids. This kind of braid is for women to be beautiful. Another one is to make three or more strends of ropes into one braid. This kind of braid is for the ropes to be strong. Another kind of braid is the stream braid. In large rivers, the stream channels sometimes can be divided in to three or more branches. This kind of branched river channel is called braided river. However, since each branch channels are not stable, they change all the time depending on the supply of water and sediment from the upstream. The braid used here for the river is to be dynamic. In summary, braids are strong, beautiful, and dynamic.

Meta as a prefix means after or beyond such as in Metaphysics, Metadata, Metaprogramming. I use meta in metabraid in similar ways.