Rob Arnott is a bit of a contrarian legend. While most of Wall Street spends its time trying to guess which AI stock will moon next, Arnott and his team at Research Affiliates have spent decades proving that the very way we build stock market indexes is, well, fundamentally broken.
If you own an S&P 500 index fund, you’re basically a "momentum chaser" by default. That's a hard pill to swallow for passive investors. But think about it: in a market-cap-weighted index, the more expensive a stock gets, the more of it you own. You’re buying more of the stuff that has already surged and less of the stuff that is actually a bargain.
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Honestly, it’s the exact opposite of "buy low, sell high."
The "Smart Beta" Revolution That Wasn't Supposed to be Trendy
Back in 2002, Rob Arnott founded Research Affiliates with a pretty simple, albeit radical, idea. He called it the Fundamental Index (RAFI™). Instead of weighting companies by their stock price (market cap), he decided to weight them by their actual economic footprint. We’re talking about real-world numbers:
- Total Sales
- Cash Flow
- Dividends
- Book Value
Basically, if a company is a huge part of the economy but its stock price is currently in the gutter, Research Affiliates thinks you should own more of it, not less.
This approach eventually got slapped with the "Smart Beta" label. Arnott has mixed feelings about that term now. In recent papers, he’s actually suggested the term has been so misused by marketing departments that it might be time to retire it. Why? Because true smart beta is about breaking the link between price and weight. Most "smart beta" products today are just expensive ways to tilt toward certain factors without actually fixing the "buy high" problem.
Why Indexing is "Broken" in 2026
We’ve entered a weird era. As of early 2026, the concentration in major indexes has reached levels that make even seasoned pros nervous. When you look at the research coming out of the Newport Beach-based firm lately, there’s a recurring warning: the "Membership Privilege."
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Arnott recently pointed out a fascinating, almost tragic, pattern in how stocks join the S&P 500. By the time a company is "big enough" to be added to the index, it has usually just finished a massive, multi-year rally. The index buys it at the peak.
Then, when a company is "small enough" or "bad enough" to get kicked out, it's usually at its lowest valuation. Research Affiliates' data shows that these "nixed" stocks—the ones dumped by the big indexes—often go on to outperform the very index that fired them over the next five years.
It’s a classic case of institutional herd behavior.
The AI Vibe Check
You can't talk about Rob Arnott today without mentioning bubbles. He’s been vocal about the AI craze, comparing it to the Nifty Fifty of the 70s or the Dot-com boom of the 90s. It’s not that the technology isn't real. It's that the price people are paying for it assumes nothing will ever go wrong.
Research Affiliates isn't saying "don't own tech." They're saying "don't own tech just because the price went up." Their RACWI (Research Affiliates Cap-Weighted Index) is a newer attempt to fix this. It keeps the "shape" of a traditional index but uses a fundamental filter to decide who gets in the door. It’s like a bouncer at a club who doesn't care how fancy your car is; he just wants to see your actual bank statement.
The Revaluation Alpha Trap
One of the most insightful things the firm has published recently involves "Revaluation Alpha." This is a fancy way of saying that a lot of "expert" investors look like geniuses only because the valuations of the stocks they own have expanded.
If a factor (like "Quality" or "Low Vol") returns 10% a year, but 8% of that came from people just being willing to pay more for those stocks, that’s not a repeatable strategy. Valuations can't go up forever. Arnott and his colleagues, like Chris Brightman, argue that we need to look at Structural Returns—what’s left after you strip away the "popularity contest" gains.
What You Can Actually Do With This Information
Most people read about Research Affiliates and think, "Cool, but I just have a 401(k)."
You don't need to be a quant to apply these insights. The core takeaway from Arnott’s life work is that rebalancing is the only "free lunch" in town. Most people rebalance once a year, or never. But the RAFI approach is essentially a machine that rebalances for you by constantly selling what has become expensive and buying what has become cheap.
If you’re looking to move beyond the "Magnificent Seven" or whatever the 2026 version of that group is, here is how to think like a Research Affiliates analyst:
- Check your concentration: If 30% of your "diversified" portfolio is in five stocks, you aren't diversified; you're betting on a narrative.
- Look at Emerging Markets: Research Affiliates has long maintained that the best value isn't in the U.S. Large Cap space. It's in the unloved, "scary" corners of the world where valuations are at 10-year lows.
- Don't fear the "Deletions": When a stock gets kicked out of an index, that’s often the best time to look at its fundamentals. The forced selling by index funds creates an artificial discount.
- Use the Tools: The firm actually provides a free tool called Asset Allocation Interactive (AAI). It’s surprisingly transparent for a multi-billion dollar firm. You can go in and see their 10-year return forecasts for almost every asset class.
The reality is that Arnott’s "Fundamental Index" has its periods of underperformance. When the market is in a "speculative blow-off" phase—where prices go up just because they’re going up—value-based strategies look stupid. They look "wrong."
But as Arnott often says, in investing, being "early" feels exactly the same as being "wrong" until the bubble pops.
Next Steps for Your Portfolio
Go to the Research Affiliates website and look up their current Capital Market Expectations. If you see that your favorite asset class has a 10-year expected real return of 0% or 1%, it might be time to stop adding new money to that bucket. Look for the "Value" and "Emerging Markets" tabs—they are often where the highest long-term yields are hiding when everyone else is looking at the latest tech headlines.