Overview of Focusing on Growth (Not Market Cap)
In this Bloomberg At the Money segment, Barry Ritholtz talks with Rob Arnott, founder of Research Affiliates, about a new way to build a growth index that does not rely on market-cap weighting. The core argument: growth and value are separate dimensions, and “growth” should be defined by actual business expansion, not by valuation labels. Arnott explains the Research Affiliates Growth Index (RAFI Growth), how it identifies fast-growing companies, and why weighting them by their real economic contribution may produce better long-term results than traditional cap-weighted growth benchmarks.
Main Ideas and Themes
Growth vs. value is not a binary
Arnott pushes back on the common investing shorthand that everything is either “growth” or “value.”
- Cheap vs. expensive is one dimension.
- Fast-growing vs. slow-growing is another.
- A stock can be expensive without being “growth,” and vice versa.
His point: investors should stop treating valuation as a proxy for growth quality.
Traditional cap-weighted indexes may overconcentrate risk
The discussion starts from the concern that market-cap weighting, especially in indexes like the S&P 500, has led to:
- heavier concentration in a few mega-cap stocks
- elevated valuations
- more portfolio risk tied to a small number of names, especially the “Magnificent Seven”
How the RAFI Growth Index Works
Step 1: Select companies based on actual growth
The index looks for companies with strong growth in:
- sales
- profits
- R&D spending
If R&D data is unavailable, it uses the available measures and averages the growth rates.
Step 2: Include only the fastest growers
Only companies in roughly the top 25% of growth rates qualify.
Step 3: Weight by dollar contribution to growth
Instead of weighting by market cap, the index weights companies by the absolute dollar magnitude of their growth contribution to the economy.
That means:
- a giant company growing 5% may be less important than a smaller company growing very rapidly
- but a tiny company with huge percentage growth does not automatically dominate the portfolio
This avoids both extremes: overpaying for size and overallocating to speculative micro-caps.
Notable Examples
Magnificent Seven exposure is selective
Arnott notes that not all megacap winners make the cut.
- NVIDIA and Apple do qualify and are among the largest weights
- Amazon and Microsoft do not qualify under this methodology
The implication is that even among dominant tech firms, inclusion depends on current growth rates, not past status or sheer size.
Performance and Risk
Strong historical outperformance
Arnott says the methodology would have outperformed Russell Growth by about:
- 4% annually over nearly 30 years
He also notes the live tracking since last March has already shown:
- about 13 percentage points of outperformance versus Russell Growth
Expect more volatility than cap-weighted indexes
The tradeoff is that investors should expect:
- somewhat higher volatility
- occasional underperformance periods
Arnott frames the distribution as roughly:
- a normal weak year: about -2%
- a normal strong year: about +12%
He says it wins about 7 out of 10 years.
Capacity and Scalability
The strategy is not yet investable, but Arnott believes it could support meaningful assets once launched.
Key points:
- current AUM: zero because it is not yet an ETF/mutual fund
- estimated turnover: about 4–5x the S&P 500
- estimated capacity: roughly 10–20% of the S&P’s capacity
- rough capacity estimate: $1.5T–$3T
So while it is more active than a passive cap-weighted index, it still appears scalable.
Bigger Investing Lesson
Beware of data mining
A major theme in the interview is Arnott’s insistence on the scientific method:
- start with a hypothesis
- test it with data
- don’t simply search backward for a pattern that looks good
He contrasts this with the usual backtest culture, where strategies are often designed from whatever historical pattern appears best, even if it may not hold up in the future.
Bottom-Line Takeaways
- Cap-weighted growth indexes can be overly concentrated and may not reflect true business growth.
- RAFI Growth tries to identify real growth companies using sales, profits, and R&D trends.
- It weights companies by their economic contribution, not just market value.
- The strategy appears to have strong historical and live performance, but with more volatility than standard index funds.
- The product is not yet investable, though Bloomberg suggests an ETF or similar vehicle may come later.
Practical Investor Implication
If you are worried about:
- mega-cap concentration
- valuation risk
- overexposure to a few dominant stocks
then this discussion suggests considering alternatives to traditional market-cap-weighted growth exposure. The central message is simple: invest in growth based on what’s actually growing, not just what’s already large.