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Recently I had the chance to attend a breakfast at the


held by PowerShares as part of its rollout of the


(PRF) - Get Invesco FTSE RAFI US 1000 ETF Report

exchange-traded fund.

The index is based on the work of Robert Arnott, who has done a tremendous amount of innovative research to try to make index investing more efficient. PRF's methodology involves screening for book value, earnings, revenue and dividends. Each stock gets a score based on the criteria, and is then weighted in the index based on its score.

The motivation for creating this index, and by extension the fund itself, is Arnott's belief that ordinary market-cap weighting of indices creates a bias toward growth stocks that are overvalued. By quantitatively scoring potential components, the process removes the growth bias.

The track record for success, based on Arnott's back testing, is excellent. It beat the

S&P 500

hands down in seemingly every market condition, and does so with a slightly higher dividend yield.

Furthermore, early indications are that the methodology works for foreign stocks too, both emerging and developed.

You might think it's time to back up the truck. Not so fast, my friend.

Despite the fact that PRF and the S&P 500 currently overlap

General Electric

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Exxon Mobil

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(MSFT) - Get Microsoft Corporation Report



(C) - Get Citigroup Inc. Report

in their top four, it looks as though PRF has closer correlations to small-cap value as measured by the

iShares S&P Small Cap 600/Barra Value

(IJS) - Get iShares S&P Small-Cap 600 Value ETF Report

fund and mid-cap value as measured by the

iShares Russell Value Index

(IWS) - Get iShares Russell Mid-Cap Value ETF Report


At the breakfast, Arnott touched on the fact that PRF does tend to have a smaller cap than the S&P 500, with a tilt toward value.

From this table it appears that PRF might be a better proxy for mid-cap value or small-cap value.

Admittedly, this may be too short a time period to look at, but the last few years have had feast, famine and flat returns, and PRF is repeatedly closer to the mid-cap value and small-cap value results than it is to the S&P 500 results.

I would not have thought to even look at this but for Arnott's comments. These comparisons could be very important for investors who use broad-cap size or style ETFs to build their portfolios. On the surface, PRF clearly looks like it is meant to capture, and enhance, large-cap stock exposure.

A more well-known example of this concept is the

Rydex Equal Weight ETF

(RSP) - Get Invesco S&P 500 Equal Weight ETF Report

, which has outperformed

S&P Depositary Receipts

(SPY) - Get SPDR S&P 500 ETF Trust Report

ever since RSP started trading. RSP is not a better fund, but it captures a different part of the market, a smaller part. Ever since the market peaked, small- and mid-cap stocks have soundly outperformed large-cap ones, so it makes sense that RSP has beaten SPY.

This notion appears to apply to PRF. Any look under the hood would reasonably lead you to think this is a large-cap product. But combining PRF with small-cap and mid-cap funds may result in less diversity and more overlap than intended.

An argument that says PRF is large-cap and not a proxy for something else is no doubt plausible, but PRF does quack like a smaller-cap product.

At the time of publication, Nusbaum held no positions in the stocks mentioned.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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