Research Affiliates founder Rob Arnott has revealed a leveraged long-short investment strategy that has doubled the S&P 500’s returns over the past eight months. The prominent investor shared that his personal brokerage account generated a 36.67% return since mid-May using this approach, while the S&P 500 returned approximately 14% during the same period, according to screenshots he provided to Business Insider in a Thursday interview.
Arnott’s strategy builds upon the concept behind his RACWI US ETF (RAUS), which launched in September. The fund employs a fundamental approach to passive indexing by identifying companies with attractive valuations and characteristics, then weighting them by market capitalization.
Understanding the Long-Short Investment Strategy
The innovative approach focuses on the 5% of stocks that do not overlap between RAUS and the S&P 500. Arnott takes long positions on stocks his index includes that the S&P 500 excludes, while simultaneously shorting stocks that appear in the S&P 500 but not in his fund. He amplifies these positions using leverage, going 200% long and 200% short to maximize potential returns.
“One really fun strategy is what if we go long our non-overlap holdings, strip out the whole 95% that’s overlapped, just go long our 5% non overlap and let’s short the S&P’s 5% non overlap,” Arnott explained in the interview. He expressed that he wished this concept had occurred to him in 2021 when Research Affiliates launched its Cap-Weighted Index, on which RAUS is based.
Examples of Stock Selection
While Arnott could not disclose specific stocks in his current portfolio for compliance reasons, he previously listed examples of holdings. In September, he identified Palantir, DoorDash, and CrowdStrike as S&P 500 constituents not included in RAUS. Meanwhile, stocks like Xerox, Zoom Communications, and Rivian Motors represent examples of RAUS holdings absent from the S&P 500.
Criticizing Traditional Index Fund Methodology
Arnott’s investment strategy stems from his belief that traditional passive indexing contains fundamental flaws. He argues that passive indexes like the S&P 500 add stocks following periods of outperformance, only to remove them after underperformance—a pattern he considers counterproductive to wealth building.
A colleague of Arnott’s illustrates this inefficiency with a hypothetical proposition: “I’ve got this great strategy: I’m going to buy stocks when they’ve just doubled and when they’re trading at twice the market multiple, and I’m going to sell stocks when they’ve just fallen in half,” Arnott recounted. “Most people would listen to that and say that’s stupid, but that’s the way index funds trade.”
The Dillard’s Department Store Example
In September, Arnott demonstrated this inefficiency using Dillard’s Department Store as a case study. The retailer has been removed from and added back to the Russell 1000 index four times over the past quarter century. According to Arnott, during the 22 years when Dillard’s was a member of the Russell 1000, it underperformed the index by 99%.
However, during the 13 years when Dillard’s was excluded from the index, it generated 67 times the wealth of the Russell 1000, according to Arnott’s analysis. This dramatic disparity underscores his argument about the timing inefficiencies inherent in passive index fund rebalancing.
As RAUS continues to track against the S&P 500 with its 95% overlap, investors and market observers will monitor whether Arnott’s alternative indexing approach and his personal leveraged strategy can maintain their outperformance over longer time periods. The ultimate test will be how these investment strategies perform through various market cycles and economic conditions.
