Can Fundamental Weighting Help Stock Investors Increase Their Returns?

Where are all the undervalued stocks? With the broader market sticking near all-time highs, it is hard to find investments that look attractive. Many investors look at analyst price estimates to determine whether a stock is a buy, sell, or hold. But what if you could find value opportunities without even considering price?

One such way is weighting stocks by their fundamentals instead of their market value. Market-capitalization weighting allows market prices to dictate the value of a company. Alternatively, fundamental weighting tilts the portfolio toward stocks with strong revenues, book values, and cash flows relative to their price.

For example, Invesco RAFI US 1000 ETF PRF is an exchange-traded fund that uses fundamental factors unrelated to a stock’s price to determine its value in the portfolio. In contrast, iShares Russell 1000 Value ETF IWD pulls from the same universe of stocks and uses fundamentals to assemble its holdings, but it sets weights according to the company’s market cap. In both cases, the larger the company, the larger the position in the portfolio. Yet, how they define a company’s size differs. The result is two ETFs with similar value exposure, but the weighting and construction mechanisms have delivered different results.

Fundamental Weighting Versus Market-Cap Weighting

IWD tracks the Russell 1000 Value Index. The 1,000 largest US stocks are split between value and growth indexes based on fundamental measures like P/B ratio, earnings growth forecasts, and historical sales growth. The fastest-growing and highest-valued stocks go into the growth index, and vice versa for value. Stocks in the middle half of scores receive partial allocations to both indexes. As a result, IWD holds approximately 870 stocks with minimal exposure to growth stocks. Stocks are then weighted according to their market cap, which favors larger companies over small ones. As the price of the underlying stocks rises, so do their weights within the portfolio.

In a fundamentally weighted strategy like PRF, the stock selection and weight allocated to each stock are set by factors such as book value plus intangibles, adjusted sales, and adjusted cash flow, among others. Unlike IWD, weights are not tied to their prices.

PRF’s rebalance process further accentuates the differences between fundamental and market-cap weighting. If a stock’s price increases, its weight within each portfolio will also increase. Cap-weighted ETF portfolios allow changing stock prices to set weights, while fundamentally weighted ETF portfolios sell stocks whose price grew faster than their fundamentals—or buy stocks whose price dropped faster than fundamentals—at the next rebalance. Over time, this creates a pattern of buying companies whose valuations become cheap and paring back those with valuations on the rise. The potential downside of this approach is that the strategy can overallocate to companies that are declining in value and never recover. The price of a stock takes into account market sentiment and information that may not yet appear in its fundamentals.

Despite these differences in weighting methodology, the funds’ style profiles appear nearly identical. Both portfolios sit in the large-value space of the Morningstar Style Box.

Similar Style Doesn’t Always Mean Similar Performance

Despite their similarities in the style box, PRF has significantly outperformed IWD since its inception in 2005, as seen in the chart below.

Had an investor put $10,000 into each fund on Jan. 1, 2006, their investment would have grown to $46,170 for IWD and $66,821 for PRF as of Sept. 30, 2025. While PRF’s outperformance is clear, there were two periods in particular where it built its advantage: The years following the global financial crisis and the coronavirus drawdown. PRF’s contrarian rebalance style works exceptionally well during periods of market turmoil. It purchases a larger quantity of stocks that have dropped in price but whose fundamentals have remained intact. This naturally creates a buy-low, sell-high effect that leads to the outperformance seen above.

Looking at 12-month rolling excess returns gives a better view of PRF’s outperformance during market volatility.

The chart demonstrates that PRF’s $20,000 advantage over IWD during the last 20 years mostly stemmed from a collection of a few short bursts of fundamentally healthy companies realizing their true value. Still, PRF generated positive excess returns over most 12-month periods and never gave up much ground to IWD.

Risks for Consideration

Returns aren’t the only consideration. Risk plays an important role in investors’ portfolios. To test whether the narrative changes when taking risk into account, the below chart shows the 12-month rolling standard deviation of both IWD and PRF since 2006.

The same periods when PRF significantly outperformed IWD coincided with spikes in volatility. Volatility was most pronounced during the global financial crisis. In 2008, PRF’s price dropped over 40%, and IWD dropped just under 37%. Volatility remained high during the recovery the following year. In 2009, PRF returned over 41%, while IWD produced just 20%. The relatively small difference in volatility produced more than double the return during the recovery period.

The funds’ volatilities remained in line with one another during most other periods, suggesting PRF’s higher returns didn’t come from taking greater risk.

In Conclusion

Both fundamentally weighted PRF and market-cap-weighted IWD are great options for an investor looking to add value exposure to their portfolio. But their different weighting methodologies have produced different results. IWD is a great option for an investor looking for cheap, straightforward value exposure. PRF is the right option for contrarian investors willing to accept slightly higher volatility and lumpy outperformance during recoveries from volatile markets.