Robert Arnott: The Rebel Investor Who Outsmarted the Market

Bucking convention can pay off big—just ask maverick investor Robert Arnott. While others played by the rules, this trailblazer forged his own path, cementing his status as one of today’s most influential investment strategists.

In this article, we’ll delve into the life, career and one-of-a kind investment strategies of the legendary Robert Arnott. See how going against the grain made Arnott a household name—and how you can apply his wisdom to catapult your wealth.

Early Years and Education: From Science to Finance

Imagine the picturesque coastal city of Santa Barbara, California, where the Pacific Ocean meets the Santa Ynez Mountains.

This is where Robert Arnott’s story begins. Born and raised in this tranquil city, Robert was always destined to make waves- not in the Pacific, but in the world of finance.

From an early age, Robert had a knack for numbers. As a high school student in 1970, he was selected for the prestigious Summer Science Program, an opportunity that only a few bright minds get. This was the first indication of the intellectual prowess that would later shape his career.

But as college loomed, Arnott found himself teetering on the cusp of a life-altering decision. Pursue a career in astrophysics or finance? His heart leaned towards the stars, but his head doubted he had the mathematical prowess for it.

So, Robert hatched a plan. He would bridge the gap between science and business. By applying the scientific method to the world of finance, he believed he could become a trailblazing investor rather than a mediocre astrophysicist.

His passion for astronomy? That would remain a cherished hobby, a private love affair with the cosmos.

Satisfied with his decision, Robert Arnott forged ahead and earned a bachelor’s degree in Economics from the University of California, Berkeley. This is an esteemed institution known for its rigorous academic standards. But Robert didn’t just survive these standards; he thrived, proving his mettle in the field of economics.

Of course, Robert was not one to do the bare minimum. He pushed himself even further, earning an MBA from the University of Southern California. This degree added another feather to his cap, equipping him with the tools and knowledge needed to navigate the complex world of finance.

Career History and Rise to Prominence

After college, a fresh-faced Robert Arnott starts working as a global equity strategist at Salomon Brothers. Then in 1998, he becomes chairman of First Quadrant, an investment management firm specializing in equities.

But in 2002, Robert Arnott decided to take the plunge and establish his very own investment management firm. It’s called Research Affiliates, and it’s located in the sunny coastal city of Newport Beach, California.

The Rise of Research Affiliates

With a powerful combination of intellect and innovation, Arnott’s firm quickly carved a niche for itself in the competitive world of finance. It emerged as a global leader in smart beta and asset allocation.

And by 2023, Research Affiliates is no longer just a fledgling firm. It’s a financial powerhouse, managing a staggering $130 billion in assets worldwide.

At the heart of this success are the investment strategies developed by Research Affiliates, one such strategy being their fundamental indexing approach.

This strategy, the brainchild of Research Affiliates, has now been adopted by countless investors, helping them maximize returns while minimizing risks.

But wait, there’s more! Beyond his vast array of achievements, Robert Arnott has also graced the Product Advisory Boards of the Chicago Mercantile Exchange and the Chicago Board of Options Exchange. His unyielding drive and relentless energy have kept him at the forefront of the exhilarating world of investment.

Of course, Arnott’s success hasn’t gone unnoticed. He’s become a frequent guest on financial news networks like CNBC, Bloomberg TV, and Fox Business, sharing his insights and expertise with millions of viewers.

But that’s not all. Major financial publications such as the Wall Street Journal, the New York Times, and the Financial Times have also featured his work, further solidifying his reputation as a leading figure in the world of finance.

Like a rebel cowboy riding against the herd, Arnott’s journey demonstrates how defying conventional “wisdom” and crafting your own path can wrangle returns in investing—if you have the guts and grit to do it.

A Guide to Robert Arnott’s Investment Philosophy

But what exactly led Robert Arnott to such heights of success? Let’s examine his unique investment approaches to see how they can apply to you!

Fundamental Indexing: Pioneering a New Method

In the world of investing, there are as many strategies as there are investors. One such strategy, fundamental indexing, was pioneered by Robert Arnott himself.

According to him, “One of the beauties of the fundamental index is that it weighs the sectors according to how big they are in the macroeconomy. It doesn’t chase bubbles. It doesn’t chase fads. It will underweight all of the fads.”

Unlike traditional methods that rely heavily on market capitalization, fundamental indexing is a rules-driven approach that selects stocks based on fundamental measures, like revenue or dividend rates.

Arnott posits that this approach, rooted in a deeper understanding of the market’s fundamentals, can provide investors with an edge to outperform the market in the long run. It’s akin to choosing a football team not just based on their past wins, but also considering the players’ skills, the coach’s strategy, and even the team’s morale.

So how can investors do this? Well, it’s about understanding where you work, where you live, and how these factors can impact your investment strategy.

For instance, if you work in the tech industry, it might be risky to invest heavily in tech stocks as well. This is because if the sector takes a hit, you could lose both your job and your investment. Similarly, if you live in an area with a booming real estate market, you might consider investing in that sector.

In essence, Arnott’s approach to investing is like a well-balanced meal. It’s not just about having one ingredient, but a mix of different elements that work together to achieve overall financial health.

Value Investing: Uncovering Market Gems

Another key component of Arnott’s approach is value investing, an approach pioneered by the famous Benjamin Graham.

But what is value investing? It’s a strategy that involves buying stocks that appear to be undervalued by the market. In simpler terms, it’s like finding a designer dress on sale at a discount store. You’re getting more than what you’re paying for.

Arnott, much like Graham, believes in long-term value investing. He understands the market can be irrational in the short term. But he knows that in the long run, it corrects and recognizes true stock value.

Arnott once said, “Value investing has had a really difficult past 15 years or so that I think has been humbling for a lot of value managers in a lot of quants that are big into value investing.”

However, in an article from Financial Review, Arnott shared his optimistic outlook for value investors, predicting they are set for a “stupendous decade.”

He advises us to prepare for a sustained period of elevated inflation, which he believes will cause value stocks to outperform their growth counterparts significantly. This is like saying the designer dress you bought on sale is about to become the next big fashion trend.

So how do we mimic this approach? Search for stocks with growth potential that the market hasn’t properly valued yet! Of course, to do this you’ll need to dive into research and buck the trends, which brings us to our next point.

Contrarian Investing: Defying the Crowd

Rob Arnott is also a master of contrarian investing, a strategy that may sound counterintuitive at first.

It involves buying assets that are currently out of favor with the market and selling those that are popular. Think of it as going against the flow of the crowd, betting on the underdog, so to speak.

Why would anyone want to do that? Well, Arnott’s contrarian approach is rooted in the belief that the market is not always efficient. He believes that there are opportunities to make a profit from these market inefficiencies.

To put it in simple terms, imagine a popular restaurant that everyone raves about. The food is good, the ambiance is great, and the prices are high.

But just down the street, there’s an overlooked eatery serving equally delicious food at a much lower price. The contrarian investor would be the one to dine at this second restaurant, recognizing its undervalued potential.

In a 2023 article published by Research Affiliates, Arnott discussed the importance of contrarian timing in smart beta strategies. These strategies involve emphasizing factors or strategies trading cheap relative to their own historical norms, and deemphasizing the more expensive ones.

Need an example? It’s like choosing to invest in classic, reliable cars when the market is going crazy over flashy, overpriced sports cars.

The idea is to spot value where others don’t, to see potential in places where others overlook. And while this approach may require patience and a fair amount of courage, as Arnott’s success shows, it can certainly pay off.

Diversifying: How Robert Arnott Manages Risk

Robert Arnott, the founder of Research Affiliates, has a portfolio that’s designed with medium risk in mind. It’s made up of:

• 30% stocks
• 60% bonds
• 10% commodities.

This mix of assets is his way of achieving balance and stability. By spreading his investments across multiple asset classes and countries, Arnott aims to minimize the potential impact of any one region’s financial crisis.

However, Arnott also warns about the pitfalls of over-diversification. In his paper, “Is Diversification Dead?”, he explains the paradox of diversification.

What’s his thesis? In a roaring bull market, when stocks are soaring, investors may regret every penny they put into diversifiers like bonds or commodities, which generally offer lower returns. On the other hand, in a secular bear market, when stocks are falling, they regret every penny they did not put into these diversifiers, which can help cushion the fall.

So, how can investors strike the right balance? It’s about diversifying, but not to the point of diluting your portfolio.

You don’t want to spread your investments so thin that they underperform. It’s like making a fruit salad – you want a variety of fruits for flavor and nutrition, but if you add too many different types, you might end up with a confusing, unappetizing mess.

Similarly, in investing, a well-rounded, diversified portfolio can help mitigate risks, but adding too many different investments can also lead to potential underperformance.

Smart Beta Investing: Everything You Need to Know

Robert Arnott is also a strong proponent of smart beta investing. But how does it work?

Well, it’s a blend of passive and active investing strategies, designed to extract the best of both worlds.

Picture it this way: you’re at a buffet, and you have two options. The first is a pre-made plate of food (like an index fund in passive investing), and the second is a chef waiting to cook your meal to order (similar to a stock picker in active investing).

Smart beta investing is like being able to pick some items from the premade plate and having the chef customize the rest. You’re not entirely leaving your meal to chance, nor are you spending excessive time and money on a fully-customized dish.

So what’s the point? The aim of smart beta investing is threefold. First, it seeks to achieve alpha, which in investment terms is the excess return on an investment relative to the return on a benchmark index.

Second, it aims to lower risk. And third, it aspires to increase diversification. All of these are achieved at a cost that’s lower than traditional active management, and only slightly higher than straightforward index investing.

Arnott’s advocacy for smart beta investing is rooted in its practicality and potential for significant returns. For instance, in 2008, when the market was in freefall, Arnott’s firm introduced a series of smart beta funds that used alternative indexing strategies. These funds outperformed traditional market-cap weighted indices, proving the effectiveness of this strategy.

So, if you’re looking for a middle ground in your investment approach, smart beta investing could be an option worth exploring.

Investing Abroad: Expanding into New Markets

A significant part of Robert Arnott’s strategy is investing beyond the borders of the United States and exploring emerging market stocks.

It’s like hunting for treasure in uncharted territories rather than sticking to familiar grounds. But why does he do it?

Arnott, in a Bloomberg article, likened US markets to a high-priced store where bargains are hard to find. He suggested that better value could be discovered abroad or in new, burgeoning markets.

For instance, imagine you’re shopping for a designer bag. You could go to a high-end store in a posh neighborhood, but the prices are steep. Or, you could explore a less glamorous part of town or even an online marketplace where you might find the same bag at a significantly lower price.

That’s the allure of non-US and emerging market stocks. They offer potential for great returns, often at a fraction of the cost.

But Arnott’s strategy doesn’t stop there. He also recommends considering other diverse investment options like Treasury Inflation-Protected Securities (TIPS), global real estate, and master limited partnerships in energy and other resources.

Multi-Factor Strategies: Pour Your Money In Now

Back in 2016, Rob Arnott raised eyebrows when he cautioned investors about the perils of investing in multifactor strategies.

He explained that there were too many potential pitfalls, including a false sense of diversification and disappointing profits from crowded trades. In 2019, Arnott wrote “Even if a factor has a true structural risk premium, real-world returns can disappoint once the factor becomes crowded.”

That’s why, prior to today, Research Affiliates primarily used global tactical asset allocation and tax-advantaged equity management to drive their investments.

But fast forward to 2023, and Arnott seemed to have changed his tune, now advocating for pouring money into multi-factor strategies. This might seem contradictory, but let’s delve deeper into what multifactor strategies actually are.

Multifactor strategies refer to investment strategies that blend a variety of factors or strategies with the aim of achieving superior long-term performance. Just as a chef combines different ingredients to create a delicious meal, an investor combines different factors to create a profitable investment strategy.

But what sets multi-factor investing apart from fundamental indexing?

While fundamental indexing focuses on a single factor (like a company’s size or fundamentals), a multi-factor strategy broadens the spectrum by considering added factors. These include:

• value
• size
• momentum
• low volatility

Multi-factor investors delve into the historical return premium of each factor, actively cherry-picking a subset of stocks based on their findings.

Now, how can investors use multi-factor strategies? Let’s use a real-world example.

Say you’re an investor who wants to diversify your portfolio. You could invest in a mix of small-cap stocks (size), undervalued stocks (value), stocks with strong upward price trends (momentum), and stocks with stable prices (low volatility).

By doing so, you’re not putting all your eggs in one basket, but spreading your investments across different factors, which could potentially lead to higher returns over the long term.

The Robert Arnott Effect on Modern Investing

Arnott’s impact on the investment landscape is nothing short of remarkable. He pioneered the concept of fundamental indexing, a revolutionary approach that has significantly influenced the world of smart beta investing.

But Arnott doesn’t just walk the walk; he talks the talk. This investing outlaw has also penned a prolific pile of articles on everything from asset allocation to portfolio gambits—leaving no stone unturned.

These works provide practical insights that help investors navigate the complexities of the market. They dissect the nuances of asset allocation, portfolio management, and risk control, making them invaluable resources for both seasoned professionals and novice investors.

Of course, Arnott’s groundbreaking work has earned him recognition and respect from his peers. For five consecutive years, he was ranked as the #1 “Most Influential Global Investment Strategist” by Institutional Investor.

And that’s not all. His contributions to the investment industry were further acknowledged when he was awarded the Nicholas Molodovsky Award by the CFA Institute. This esteemed award is given to individuals who have made significant contributions, further solidifying Arnott’s place as a transformative figure in the field.

Conclusion: Why Invest like Robert Arnott?

Robert Arnott is a visionary investor who has revolutionized the field of finance with his innovative and contrarian strategies. His strategies, from fundamental indexing to smart beta, have upended the status quo and paved new paths for extraordinary returns.

Whether you’re a beginner or an expert, you can learn a lot from Robert’s insights and experience. If you want to discover more about his philosophy, check out his most insightful quotes on investing. Who knows? You might unearth a golden nugget that propels you toward your financial dreams.

Frequently Asked Questions

Let’s answer some frequently asked questions investors are dying to know about Robert Arnott and his investment firm!