Investors who want equity exposure but are wary of potential downturns in a volatile market ahead may consider a recently launched smart-beta exchange traded fund strategy that employs behavioral momentum factors to help capture upside while limiting downside risks.
The Aptus Behavioral Momentum ETF (BATS: BEMO) tries to reflect the performance of the Aptus Behavioral Momentum Index, which utilizes a rules-based methodology to implement a trend-following strategy.
“We have seen advisors building BEMO into the US Equity sleeve of their allocations,” John David Gardner, founder of Aptus Capital Advisors, told ETF Trends. “BEMO’s ranking system and concentration may provide favorable upside capture in a healthy bull market, which is attractive to advisors. But given the environment we are in where returns have been hard to find and correlations are elevated, advisors appreciate having a system in place to help mitigate risk of major drawdowns.”
Specifically, the underlying index is exposed to either common stock of approximately 25 U.S.-listed companies based on momentum and investor behavior factors or shares of U.S. Treasury bond ETFs, depending on the risk outlook.
“The ability to adapt is critical and by focusing on investor behavior we continually adjust to the environment we are in,” Gardner said. “The best stocks to own are the ones that make the most new highs. We want to be involved where good things are happening and where buyers and sellers are continuing to agree at higher prices. But, we also want to have an effective system in place to avoid the difficult market environments.”
Gardner described the rules-based indexing methodology as a three-step process running on a rolling 28 day cycle. First off, the index takes the pulse of the market to determine if the environment is favorable for equities. If no, the index will overweight Treasuries, but if yes, it ranks the 500 largest U.S. stocks. Then, the index invests with conviction to the highest ranked components based on investor behavior and momentum.
“Investor behavior is the biggest risk to investor success and the behavior gap is a well-documented topic,” Gardner said. “Academic theory has a difficult time modeling human behavior which makes the transfer of backtested paper performance to real world portfolios difficult. How you get from point A to point B matters, and the behavior between those two points determines how much you get of what the market is going to give.”
The ETF employs a type of smart-beta indexing methodology that includes an active component in the way it selects its holdings and the frequency at which it rebalances to adhere to its strategy.
“BEMO provides the benefits of an index based ETF, but the index is not asleep at the wheels,” Gardner added. “Behavioral Momentum is sensitive to market changes by continuing to refine in favorable markets but also has the ability to step out of equities if the environment dictates that. The uncertain environment we are in makes the value proposition of Behavioral Momentum that much more compelling and the ETF structure makes access to the methodology easily accomplished.”
BEMO’s current sector allocations include consumer cyclical 3.7%, financials 4.3%, real estate 8.5%, telecom 8.2%, energy 4.1%, industrials 8.0%, tech 3.8%, consumer defensive 26.7%, healthcare 4.0% and utilities 28.6%. The sector weights more or less conform with current market trends, with overweight positions in outperforming utilities and underweight underperformers.
Top holdings include Ameren Corp (NYSE: AEE) 4.1%, American Water Works (NYSE: AWK) 4.3%, Cincinnati Financial Corp (NasdaqGS: CINF) 4.2%, CMS Energy Corp (NYSE: CMS) 4.1% and Campbell Soup (NYSE: CPB) 3.7%
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