You may have heard of Warren Buffett. If you haven’t, please let us know where you live. We want to come there. Buffett made all of his money by identifying companies that are worth more than the price the market was willing to pay for them. This is what people mean when they talk about value investing. This week, we feature the Satrix RAFI 40 ETF – a product that tries to do Warren Buffett’s job so the rest of us can drink wine.

Remember before, when we spoke about ETF methodologies? To recap, companies are included in ETFs in one of two ways. The market capitalisation methodology is the more traditional way of putting together an ETF. This method multiplies a company’s share price by the amount of shares available. The higher this number, the larger percentage of the ETF is invested in the company. Smaller companies take up very little space in the ETF.

The other way is using smart beta strategies. These ETFs use different methodologies to decide which companies are included, or how much of the ETF should be invested in a given company. The Satrix RAFI 40 is a smart beta ETF.

While the Satrix RAFI 40 tracks the top 40 companies listed on the JSE, like the Satrix Top40, how much the ETF invests in each company isn’t determined by the share price multiplied by the number of shares. Instead, this ETF looks at the book value of a company, the company’s sales and cash flows over five years and the dividends paid by the company, averaged out over five years, to determine how much of the ETF should be invested in each company. The ETF invests more in companies that get a better overall score based on these figures.

While the Top 40 and RAFI track the same group of companies, the methodology changes the makeup of the ETF entirely. South Africa’s biggest company, Naspers, currently takes up 22% of the Top 40, but only represents 3.48% of the RAFI.

Weekly expert: Craig Gradidge

Each week, we ask a very smart person to explain the potential benefits and pitfalls of our featured ETF. This week, our friend Craig Gradidge from Gradidge-Mahura Investments helps us understand the Satrix RAFI 40.

What sets the Satrix RAFI apart from other ETFs in the market?

RAFI stands for Research Affiliates Fundamental Index. Research Affiliates LLC is an American investment research company. 

The RAFI 40 is one alternative an investor can consider for a non market cap weighted investment in the Top 40 shares of the JSE. The other option an investor can consider is the equally-weighted Top 40. The RAFI 40 Index is essentially a fundamental index where the weightings of the components of the index are determined by four fundamental factors instead of market capitalisation. The four fundamental factors are:

• Sales: average sales over the past five years
• Cash flow: Operating income plus depreciation over the past five years
• Book value: the company’s book value at the review date
• Dividend: Total dividends (regular and special) averaged over the last five years

The company’s position in the index is determined by their aggregate score for each factor. In theory, if the company is doing well in terms of these fundamental factors, it should do well as an investment. The universe for this fund is the Top 40 of the JSE, hence the name RAFI 40.

What limitations should investors be aware of?

The fund is an equity-only fund, and is only able to invest in Top 40 shares. The fund does not pay out dividends as these are reinvested automatically. It is suited to the investor who believes that the four fundamental factors will impact share price performance over time, more-so than market capitalisation.

What type of portfolio would benefit most from holding this ETF?

This ETF is suited to the growth investor with a long-term horizon and a tolerance for short-term capital volatility.

Unpacking the Satrix RAFI 40

*December 2018