Rob Arnott had just finished his burger when we ended up on perhaps the most interesting detail of an hourlong interview: He has seen 18 solar eclipses.
That’s quite the résumé, considering they only happen once every year and a half.
He’s traveled to see them in Antarctica and Australia. He’s seen one from a plane off the coast of Iceland; another he saw in Bhutan, and one while on a boat in the Black Sea.
“It’s the most amazing sight the sky has to offer,” Arnott, the founder of Research Affiliates, told Business Insider over lunch last week. “It’s emotional, and it’s hard to put your finger on why. On one level, you feel very small. Just a little speck in the universe. And on the other hand, you’re very moved by the sheer beauty of it.”
Initially, Arnott’s passion for the celestial phenomenon surprised me. Then I connected the dots. Earlier in our conversation, Arnott had briefly mentioned that his passion for math in high school had him split between a career in finance or astrophysics.
Ultimately, of course, he chose the former.
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“I was good at math, but not extraordinary,” he said. “To make a difference in astrophysics, you have to be extraordinary.”
What kind of career astrophysicist Rob Arnott would have had, we’ll never know. But in the world of investing, we can be certain that Arnott has made his mark.
Arnott has been a pioneer in index investing products, pointing out flaws in popular mainstream indexes like the S&P 500 that can hurt investors.
Since these indexes are passive, cap-weighted strategies, they can have an investor unwittingly overweight one sector or theme, like technology or AI. In the early 2000s, Arnott was the first to introduce alternative index strategies to the market, launching his Fundamental Index in 2005. Firms like BlackRock, Charles Schwab, Invesco, and PIMCO have funds that use Research Affiliates’ indexes.
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Today, Arnott is still launching new products that challenge market dynamics. His most recent focus is on the stocks that get kicked out of or added to the S&P 500 and other indexes. Last year, he put out the Research Affiliates Deletions ETF (NIXT), which is a collection of fundamentally attractive stocks that have been taken out of the S&P 500.
Last week, he released the Research Affiliates Cap-Weighted US ETF (RAUS), which takes a cap-weighted approach to indexing only after undergoing a fundamentals-based selection process. Arnott sees it as an improvement on the inefficiencies of the current selection and removal process for major indexes, which can diminish returns.
“One thing that I keep learning again and again and again is the resistance to change in the indexing world,” he told BI. “These are ideas that should have been advanced decades ago. And why weren’t they? Very simple: We’re trained to think about the world from a cap-weight centric perspective, not from a company perspective, a business perspective.”
Arnott’s lunch place of choice was the dining room at Gramercy Tavern in Manhattan. He ordered an iced tea along with his burger.
Though Arnott hasn’t lived in New York full time since 1988, he said he’s been frequenting Gramercy Tavern during his regular visits to the city since it’s been around.
“It’s iconic, it’s comfort food, it’s been here forever, it’s got a comfortable ambiance,” Arnott said of the place. “If I have business in this part of town, Gramercy Tavern’s a natural go-to.”
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Arnott, who is based in Miami, did indeed have business in lower Manhattan that day, bouncing around town to promote his new RAUS ETF.
The product seeks to correct a substantial defect in popular passive index strategies, which seem to disregard the investing maxim that past performance isn’t indicative of future results.
Indexes often add stocks after they’ve seen huge outperformance, which grows their market cap enough to be considered. However, Arnott’s research finds that those returns are usually not sustained. Conversely, indexes tend to kick out stocks that have suffered poor performance, which drives down their market cap. When passive investors are forced to dump those stocks, they become even more cheaply valued. Arnott’s findings show that big returns usually follow.
He cited the example of Dillard’s Department Store, a mid-cap stock that has been taken out of and added back to the Russell 1000 index multiple times.
“In the last quarter century, it has been removed from the index and added back to the index four times. So buy low, high, low, four times, and every time you’re doing enormous damage to your wealth if it’s the only stock you’re trading.”
“How big a difference does it make? It’s been a member of the Russell 1000 in 22 of the last 35 years. During those 22 years, it has underperformed the Russell index by 99%,” he continued. “In the 13 years that it wasn’t a member, it gave you 67 times the wealth of the Russell 1000.”
RAUS considers four factors, Arnott said: adjusted sales, adjusted cash flow, dividends plus buybacks, and book value plus intangibles. As it works out, the fund has about a 95% overlap with the S&P 500. About 5% of companies in the benchmark index don’t make the cut for RAUS, as their valuation levels or other fundamental factors weaken their investment case. Palantir, CrowdStrike, and DoorDash, for example, are not in RAUS.
To fill in the rest of that 5%, Arnott applies 3% of it as an extra overweight for the top 95% of holdings. The remaining 2% are about 100 attractive small-cap stocks.
This framework has beaten the S&P 500 by an average of 0.69% annually since the early 1990s, Arnott said.
“It’s an incredibly simple idea,” he said. “We’re trained to think the market is pretty efficient, big market cap means big successful future for the business, and often that’s true. And often it’s not.”
Arnott may not have gone into astrophysics all those years ago, but his inclination toward science still seems to influence his approach to investing.
“I think it’s great fun to just ask questions,” he said. “The essence of science is disagreement, and that shows up in the investing world too. Why on earth would we be the first to challenge the notion of choosing stocks for a cap-weighted index by something other than market cap?”
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Arnott’s consensus-busting ideas usually pinpoint abnormalities in the market — out-of-whack probabilities that make for attractive risk-reward ratios.
His value- and fundamental-oriented strategies aren’t quite as flashy or volatile as growth areas of the market, and don’t play out overnight, but the results materialize over time.
Toward the end of our lunch, Arnott pulled out his phone and showed me impressive, bright-orange photos snapped while chasing eclipses. For the most recent one he saw, on a ranch in Austin, Texas, in April 2024, there was cloud cover. So instead of trying to snap pictures, he decided to record a time-lapse.
In the video, people bop around in a field, eventually stopping to look up through the overcast to marvel at the darkening sky. All the while, Arnott, having everything in place well before the moment of totality, stood behind the camera and took in the excitement.
“I just set a camera up,” he said, “and let it do its thing.”