PLANADVISER - September/October 2017 - 11

A Decade of Results
The Past, Present and Future of Fundamental Index Strategies
I
t's been 10 years since Charles Schwab Investment Management, Inc.
first launched the Schwab Fundamental Index Funds* that are designed
to track indexes that utilize the Research Affiliates Fundamental Index™
(RAFI™) methodology. As one of the first providers of what is now a
staple among the wide range of strategic beta offerings, the Schwab
Fundamental Index mutual funds and ETFs provide investors with a unique
way to access the market, as well as offer the potential for excess returns
versus market cap index products.
Not all strategies are created equally
The RAFI
indexes were launched to offer a systematic way to avoid
the biases of traditional market cap indexes by removing the arbitrary
measure of market price from the equation. Instead, the Fundamental
Index strategies weight companies based on more objective, economically
based measures to determine the index weighting methodology. Using
fundamental measures such as retained operating cash flow, adjusted
sales, and dividends plus buybacks allows the strategies to remove the
potential biases of an active manager who may favor a particular stock
because of past performance or emotional attachment. This disciplined
rules-based approach weights securities by objective fundamental
measures, and minimizes the impact of excessive stock valuations through
periodic rebalancing.
The benefits of the Fundamental Index approach
The Schwab Fundamental Index products offer the potential for
outperformance relative to market cap index products over time while
retaining many of the benefits of index investing, such as broad diversification
to equity exposure and generally lower expenses as compared to actively
managed funds.
Enhanced
return
potential
Lower
expenses
Broad
diversification
A decade of outperformance
Although Fundamental Index strategies have experienced short-term
periods of underperformance, the last 10 years demonstrate the value a
Fundamental Index strategy can provide to a portfolio over the long term.
Since April 1, 2007, the Fundamental Index strategies outperformed market
cap indexes in each of the five major equity market segments, by a measure
that ranged from 50 to 220 basis points per year.1
Generating excess returns during a period of underperformance for value
relative to growth underscores the power of Fundamental Index strategies.
Fundamental Index strategies have historically been able to deliver excess
returns by breaking the link with price, weighting securities based on
fundamental measures, and then rebalancing over time. These contrarian
strategies are designed to avoid overweighting securities based on their
size or popularity. They exhibit a dynamic value tilt. The degree of the value
tilt will vary over time depending on the relative valuation of the underlying
securities. This dynamic nature of the strategies' value tilt is what allowed
them to outperform during a decade that was predominantly challenging for
value strategies.
Over the 10-year period, the Fundamental Index U.S. Large strategy
outperformed the market cap Russell 1000 Index while the international
and emerging market strategies also outperformed their market cap index
equivalent, providing value during an era that included the Great Recession,
the Taper Tantrum and the monumental Brexit vote.2
We know that when
markets get volatile, investors often move to the sidelines and then miss out
on the subsequent recovery. Investors who remained invested in Schwab
Fundamental Index mutual funds through the peaks and valleys of the past
10 years would have realized the benefits of this rules-based approach, with
the large majority of mutual funds delivering meaningful excess returns
compared to their market cap equivalents.
Looking ahead
With a decade of performance across various market environments,
the Fundamental Index strategies have been battle tested and delivered
value-add even through challenging times. By breaking the link between
price and weight they avoid overweighting overvalued companies and
underweighting undervalued companies. This creates an opportunity to
generate excess returns, as the portfolios rebalance away from market
swings and are positioned to capture upside when mean reversion occurs.
As our confidence continues in the Fundamental Index methodology,
we believe Schwab Fundamental Index mutual funds and ETFs could be
well positioned to continue to add value. It's hard to argue against the
importance of strategic beta products in portfolio building, and we believe
Fundamental Index products are poised to become an even more integral
part of a diversified portfolio.
To learn more about Schwab Fundamental Index Funds, visit schwabfunds.com/fundamental
For institutional investor use only.
Investors should consider carefully information contained in the prospectus, or if available, the summary prospectus, including investment objectives, risks, charges and expenses.
You can view and download a prospectus by visiting www.schwabfunds.com. Please read the prospectus carefully before investing.
Past performance does not guarantee future returns.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
There can be no assurance that the Fundamental Index methodologies will achieve their desired outcomes. Each investing strategy involves its own set of unique risks and benefits.
Shares of ETFs are bought and sold at market price, which may be higher or lower than the net asset value (NAV).
*Schwab is a registered trademark of Charles Schwab & Co., Inc. (Schwab). " Research Affiliates® " , " Fundamental Index® " and " RAFI® " trade names are the exclusive property of
Research Affiliates, LLC.
Not all Schwab Fundamental Index mutual funds have a 10 year history. The Schwab Fundamental Index ETFs launched August 15, 2013. For a list of all Schwab Fundamental Index funds,
please visit www.schwabfunds.com.
For a list of Fundamental Index strategy definitions, please visit www.schwabfunds.com/RAFIindexes
Charles Schwab Investment Management is the investment adviser for Schwab Funds and Schwab ETFs. Schwab Funds are distributed by Charles Schwab & Co., Inc. (Schwab),
Member SIPC. Schwab ETFs are distributed by SEI Investments Distribution Co. (SIDCO). CSIM and Schwab are separate but affiliated companies and subsidiaries of The Charles
Schwab Corporation, and are not affiliated with SIDCO.
Information and data provided have been obtained from sources deemed reliable, but are not guaranteed.
1
Data Source: Research Affiliates LLC (RA) as of 3/31/2017
2 Data Source: Morningstar Direct
©2017 Charles Schwab Investment Management, Inc. All Rights Reserved. CC (1017-701E)
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PLANADVISER - September/October 2017

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