Focusing on Growth (Not Market Cap)

Summary

Masters in Business: "Focusing on Growth (Not Market Cap)"

Host: Barry Ritholtz
Guest: Rob Arnott (Founder, Research Affiliates)
Date: May 7, 2026

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Episode Overview

This episode of Masters in Business dives into a critical theme in modern investing: why investors should reconsider traditional market cap-weighted indexes in favor of approaches that focus on true business growth. Barry Ritholtz hosts Rob Arnott, founder of Research Affiliates, to discuss the newly launched Research Affiliates Growth Index—a novel methodology that selects and weights companies based on both the speed and magnitude of their contribution to economic growth, rather than simply their market cap or valuations.

Arnott challenges the conventional duality of "growth" versus "value" and proposes a richer, multidimensional approach to index construction. The conversation covers methodology, performance, volatility, real-world implications, and even a behind-the-scenes look at what’s coming next in index investing.

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Key Discussion Points & Insights

1. Rethinking Growth & Value – Not Just a Binary Choice

• Arnott debunks the growth vs. value dichotomy:

  • "[The principle that] there's this binary duality of growth and value... Pardon me, those are not one dimension. Those are two dimensions." (03:15 – Rob Arnott)
  • It’s possible for a company to be cheap or expensive, while also growing fast or slow—these are not mutually exclusive or opposite states.

• Traditional Indexing’s Shortcomings:

  • Cap-weighted indices overly concentrate investor dollars into a handful of mega-cap names—especially “the Magnificent 7.”
  • Growth indexes typically rely on high valuations as a proxy for growth, but that can overexpose investors to expensive stocks, not necessarily the fastest growing ones.

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2. What is the Research Affiliates Growth Index?

• Constructing the Index on True Growth

  • It selects companies for index inclusion based on top 25% percentage growth, not valuation or market cap.
  • Factors considered:
    • Sales growth
    • Profit growth
    • Growth in R&D spending
  • R&D growth is a key signal—shrinking R&D is a red flag for future growth potential.

  "If you have three different growth rates—growth in sales, growth in profits, and growth in R&D spending... you average those growth rates and you've got a very good gauge of how fast the company's growing." (05:38 – Rob Arnott)

• Weighting by Dollar Magnitude

  • Once companies are selected by fast percentage growth, they are weighted by absolute dollar magnitude of growth—meaning the largest contributors to U.S. economic growth get the largest weights in the portfolio.
  • This avoids over-weighting tiny, potentially volatile companies that, despite massive percentage gains, don’t actually move the economic needle.

  "By weighting companies in proportion to the dollar magnitude, you're not going to introduce a bias towards frothy tiny companies... It might be a flash in the pan." (09:36 – Rob Arnott)

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3. Surprising Constituents & Performance

• Not All Big Tech Makes the Cut

  • Of the vaunted "Magnificent 7," not all qualify.
  • Apple and either Amazon or Microsoft (final answer: Amazon and Microsoft) do not make the index due to slower recent growth rates in revenue and R&D.

  "Two of the Magnificent Seven don't make the cut for the RAFI Growth Index... Apple has been 10% of the aggregate growth in sales or profits of the US economy." (07:25, 09:36 – Rob Arnott)

• Performance Track Record

  • The new index outperformed Russell Growth by 4.5% per annum over the past 30 years (back-tested).
  • In live tracking since it appeared on Bloomberg, it beat Russell Growth by 13% in under a year.

  "Over the last 30 years [it] would have outperformed Russell Growth by 4.5% per annum..." (03:15 – Rob Arnott) "On Bloomberg... it's already 13 percentage points in less than a year ahead of Russell Growth." (07:27 – Rob Arnott)

• Volatility and Underperformance

  • Investors must tolerate slightly higher volatility (±7% per year).
  • Outperforms 7 out of 10 years; occasionally underperforms in certain market phases.

  "You have to live with a little bit more volatility and you have to live with occasional periods when it will underperform... it wins about 7 out of 10 years." (10:26 – Rob Arnott)

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4. Practical Implementation, Liquidity & Capacity

• Liquidity and Capacity

  • No concerns at present; the AUM is zero but the index could, in theory, handle $1.5–$3 trillion in assets if it became as popular as the S&P 500, though with higher turnover.

  "I think its capacity would be 10 to 20% of the S&P... that would give us something on the order of one and a half to three trillion as a capacity." (11:37 – Rob Arnott)

• When Will It Be Investable?

  • No mutual fund or ETF exists yet, but Ritholtz promises to invite Arnott back to the show when the product launches.

  "When it becomes investable, we'll have you back." (08:05 – Barry Ritholtz)

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5. Quantitative Rigour vs. Data Mining

• Avoiding the Pitfall of Data Mining

  • Arnott stresses their use of the scientific method: start with a hypothesis, test it, and avoid “manufacturing” a better backtest with endless optimization.
  • Their approach led to the original Fundamental Index (RAFI), which has outperformed consistently both in backtesting and live markets.

  "Scientific method means you start with a hypothesis and you only use the data to test the hypothesis." (12:59 – Rob Arnott) "Go back historically and ask, what can I construct that's worked? We don't do that." (12:59 – Rob Arnott)

  • Ritholtz notes the universal tendency to promote only good backtests:

    "When do you ever see a bad back test? Right—all back tests are great." (14:10 – Barry Ritholtz)

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Notable Quotes and Memorable Moments

• On the problem with current indexes:

  "Cap-weighted indexes like the S&P 500 have really done a great job in dominating investor inflows. But ... market concentration into just a handful of stocks, especially the Mag 7, [leads to] higher valuations and increased risks for investors." (01:53 – Barry Ritholtz)

• On creating a better growth index:

  "Nobody has posed the question, why don't we look at this fundamentally instead of based on valuations?" (03:15 – Rob Arnott)

• On weighting by real dollar growth, not just percentages:

  "We select based on percentage growth... but weighting... in proportion to the dollar magnitude... avoids a bias towards frothy tiny companies." (08:32, 09:36 – Rob Arnott)

• On volatility:

  "You have to live with a little bit more volatility... it adds 4.5% a year, plus or minus 7%... it wins about 7 out of 10 years." (10:26 – Rob Arnott)

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Important Timestamps

• [01:53] – Introduction and critique of cap-weighted indexing
• [03:15] – Rob Arnott on the multidimensional nature of growth and value
• [05:38] – Mechanics of the Research Affiliates Growth Index: selection and weighting
• [07:03–07:27] – Which Magnificent 7 companies don't make the growth index?
• [08:32–09:36] – Explanation of weighting by dollar growth vs. percentage growth
• [10:26] – Volatility and performance consistency
• [11:37] – Discussion on liquidity, capacity, and index scalability
• [12:59] – Scientific method vs. data mining; RAFI’s development philosophy
• [14:10] – The reality of backtesting and making a “good” strategy

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Conclusion & Takeaways

• Traditional market cap-weighted indexes face concentration risk; value and growth are not opposites.
• A fundamentally constructed growth index—grounded in real, measurable business expansion (sales, profits, R&D) and weighted by actual contribution—can deliver superior returns, albeit with more volatility.
• Not all mega-cap tech companies pass genuine “growth” criteria, challenging the notion that size alone drives economic impact.
• The Research Affiliates Growth Index isn’t investable yet, but look for future ETF/mutual fund releases.
• Investors should scrutinize methodologies that rely on backtesting alone and seek no-nonsense, science-first solutions to indexing.

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If you seek to diversify from conventional cap-weighted strategies and want an index that reflects true business growth, keep an eye on the Research Affiliates Growth Index—and look forward to its eventual investable launch.

Transcript

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[Barry Ritholtz]

you put the load right right on. Traditional market cap weighted indexes like The S&P 500 have really done a great job in dominating investor inflows. But today there's concerns of cap weighting that is leading into increased market concentration into just a handful of stocks, especially the Mag 7. Higher valuations and increased risks for investors. How should an index investor think about this? Well, to help us unpack all of it and what it means for your portfolio, let's bring in Rob Arnott, founder of Research Affiliates. The firm recently put out the Research Affiliates Growth Index that's different from both CAP weighted ETFs but also different from equal weight ETFs. So I'm fascinated by this index which you guys put out. You're tracking it live today. It's not yet investable, but I assume there'll be an ETF out sooner rather than later. Define graphic. Define the Research Affiliates Growth Index. What are the weights based on? How do you think about alternatives to cap weighted growth?

[Rob Arnott]

Let's back up just a little bit and challenge one of the big basic principles of modern investing and modern finance. The principle that there's this binary duality of growth and value. If it's not value, it's growth. If it's not growth, it's value. Pardon me, those are not one dimension. Those are two dimensions. You can have cheap and expensive, you can have fast and slow growing. Two different, completely different dimensions. Our industry has had a fixation on this simple duality where if it's cheap, it's value and if it's expensive, it's growth. No, if it's expensive, it's expensive. It's much simpler. If it's growth, it's growth. So to my astonishment, looking back, cap weighted indexing goes back to the 50s as investable portfolios to the 70s and growth indexes to the late 70s and growth investable growth strategies to the 1980s. Nobody has posed the question, why don't we look at this fundamentally instead of based on valuations? Nobody has asked the question, why don't we create an index that chooses growth stocks based on how fast they're growing and weights growth stocks based on how big their dollar contribution to the growth of the macro economy is? If you do that, if you choose companies that are growing rapidly and you weight them on the dollar magnitude of that growth, you wind up with an index that over the last 30 years would have outperformed Russell growth by 4.5% per annum going back almost 30 years.

[Barry Ritholtz]

Russell growth, not Russell value. Correct. So if that's the case, what are we selecting on? It's not just cap weight, I'm assuming and I've read some of the research, you're looking at increasing sales, increasing profits, increasing R and D. Explain what goes in to the RAFI growth industry.

[Rob Arnott]

Well, there's an article coming out in the next issue of the Financial Analyst Journal that takes a deep dive. So anyone who's got access to the faj, take a look. For the moment, you can also find it on ssrn. Just look up Arnot Fundamental Growth and it'll take you right there. Anyway, if you wanted a growth index that didn't anchor on expensive stocks but anchored on fast growing companies, how would you instinctively choose to measure that growth? Sales, profits. Those are the obvious choices. Slightly less obvious. Most growth companies have R and D and it's a big enough part of their business that they break it out as a separate item in their P and L. So what about growth in P? L? Excuse me, growth in R D. Because if they're shrinking their R D budget, that's a bad sign. And so if you have three different growth rates, growth in sales, growth in profits, and growth in R D spending, if that's available, two of the three if it's not, you average those growth rates and you've got a very good gauge of how fast the company's growing. If. If it's growing rapidly enough to be in the top 25%, let's use it. Here's a fun factoid. Two of the magnificent seven don't make the cut for the Rafi Growth Index.

[Barry Ritholtz]

Really?

[Rob Arnott]

Which to take a guess.

[Barry Ritholtz]

So who's cutting way back on their R and D and not seeing increases in revenue? Apple and Amazon. I'm just spitballing.

[Rob Arnott]

You got one out of two.

[Barry Ritholtz]

So Apple is the first one.

[Rob Arnott]

Amazon, Amazon and Microsoft both were growing incredibly fast in the 2010s and have been growing nicely in the 2020s, but not fast enough to make the cut. So they're. They're left out of the Rafi Growth Index. The index is on Bloomberg, has been since last March, and it's already 13 percentage points in less than a year ahead of Russell Growth. So the idea works and it's exciting. I wish I was on your show to announce that it's an investable ETF or mutual fund. Not yet.

[Barry Ritholtz]

When it comes out, when it becomes investable, we'll have you back. I want to ask you a question about dollar magnitude as opposed to percentage magnitude of growth. This is something that every metric I see is almost always a percentage. You're looking at absolute dollars of growth. Explain the thinking behind this. How does it manifest in performance? How does it work?

[Rob Arnott]

We select based on percentage growth. You could have a huge company that has sales grow by 100 billion in a year and it's only 10% growth, 5% growth. And if that's the case, it's not a particularly growth company. So percentage growth is used to choose the companies. Now, the two biggest stocks in Rafi Growth are Nvidia and Apple. One has had stupendous growth from a low base. One has had good growth from a high base. Both have had percentage growth fast enough to make the cut. They are both a little over 10% of our index. Now think what that means. If it's a 10% weight, that means that Nvidia has singularly all by itself been 10% of the sales or profit growth in the aggregate US economy.

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[Barry Ritholtz]

Huge.

[Rob Arnott]

Apple has been 10% of the aggregate growth in sales or profits of the US economy. So by weighting companies in proportion to the dollar magnitude, you're not going to introduce a bias towards frothy tiny companies that have had just a big percentage surge. You could have a tiny company that's grown tenfold and if you weight it by that tenfold growth, it's going to get a huge weight and it's a tiny company and it might be a flash in the pan.

[Barry Ritholtz]

So in other words, the percentage gains matter, but so too do the real dollar gains.

[Rob Arnott]

Exactly.

[Barry Ritholtz]

I understand that. So, curious about the volatility of this versus traditional cap weighting indexes. How does this compare? Are you getting better performance but you have to live with a little more volatility?

[Rob Arnott]

The short answer is you have to live with a little bit more volatility and you have to live with occasional periods when it will underperform. On average, over the last 28 years, it adds 4.5% a year, plus or minus 7%. So in just a normal disappointing year, it's going to underperform by about 2. In a normal excellent year, it's going to outperform by about 12. So since we launched in last March, the 13% outperformance means this is a very typical, very normal good year. And so you have to be willing to to take a little bit of volatility. But if you go back, you find that it wins about 7 out of 10 years. Wow, that's pretty cool.

[Barry Ritholtz]

Yeah, to say the very least. So since we're talking about a lot of not just large cap companies, but companies with a substantial economic footprint, my assumption is there aren't a whole lot of capacity or liquidity constraints. I'm assuming this could ramp up just like an S and P index or what have you.

[Rob Arnott]

Short answer, your question is current AUM is zero, so there's loads of capacity. Longer answer is an educated guess would be it could it it it has about four times the turnover of the S&P, maybe five. So just on that alone, its capacity would be a fourth or a fifth out of the S and P. It's also tilted towards a particular category, not the whole broad market. So that would suggest another haircut. I think its capacity would be 10 to 20% of the S&P. Given that there's about 15 trillion index to the S and P, that would be. That would give us something on the order of 1 and a half to 3 trillion as a capacity.

[Barry Ritholtz]

So. So plenty of capacity. Last question. I've been watching various narratives come into favor and then fade. We went through a whole blockchain crypto set of narratives. AI seems to be in the midst of its various narratives. When you think about the Research Affiliates Growth Index, Fundamental Growth Index, does the dominant narrative matter or is it just redefining its constituents based on what is best working today? What is seeing the highest increases in revenue, profits and research and development spending?

[Rob Arnott]

Well, between Rafi, the fundamental index, which has stark value tilt, and Rafi Growth, which has a stark growth tilt, I like to think that we're launching a revolution in indexing. The Runway for this is huge. One other observation. We're quantitative investors. We love testing things. Quantitative investors are addicted to data mining. Go back historically and ask, what can I construct that's worked? We don't do that. Scientific method means you start with a hypothesis and you only use the data to test the hypothesis. Our hypothesis was if you select companies on how fast they're growing and weight them on how large the magnitude of their contribution to the economic growth, this is an idea that might work pretty darn well. And lo and behold, it does. The back tests of Rafi, when we launched it 20 years ago, showed about 2% value add relative to cap weighted value. It's added 2 to 2.5% live for 20 years. So you don't fall into the trap of creating a strategy that looks great in backtest and falls apart instantly.

[Barry Ritholtz]

I'm so glad you said that because when do you ever see a bad back test? Right. All back tests are great. That you.

[Rob Arnott]

I see lots of bad back.

[Barry Ritholtz]

Oh, no.

[Rob Arnott]

I mean, that would never promote it.

[Barry Ritholtz]

The back tests that get shared are the ones that there's a little.

[Rob Arnott]

Of course they are.

[Barry Ritholtz]

Totally. And you know, inherent in every back test is the concept that the future is going to look like the past. And very often we see the future does not look like the past. So the, the back tests all fail. Many back tests that look great fail to, to perform in real life. That's exactly because the world changes.

[Rob Arnott]

And if you, if you're doing a back test to create a better backtest.

[Barry Ritholtz]

Right. That's right.

[Rob Arnott]

That's the, that's the epitome of data mining. And it's endemic in our business.

[Barry Ritholtz]

Absolutely. So Rob, when the, when this comes out as an investable product, be it an ETF or an SMA or a mutual fund, come back, tell us about it.

[Rob Arnott]

I'm not sure it will because I'm trying to keep it secret because it's so good.

[Barry Ritholtz]

Well, you and Jim Simons like kick out all the outside investors and just keep your own money until it works well. So to wrap up, if you're concerned about cap weight, if you're concerned about market concentration or valuation, take a look at the Research Affiliates Growth Index. It's not market cap weighted, it's not yet investable. But I know Research Affiliates and I'm pretty confident there will be an ETF for you to put money into at some point in the future. I'm Barry Ritholtz. You've been listening to Bloomberg's at the Money.

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