Trading on emotions can cause one to sell too early or buy too late. However, investors can look to rules-based exchange traded funds that keep emotions out of the equation and automatically adjusts to oscillating market conditions.

“A rules-based strategy that systematically shifts allocations between stocks and cash may help curb emotional decision-making,” according to Victory Capital note. “Protracted market drawdowns are unsettling and can incite emotional and potentially destructive decision-making. So
how can investors maintain conviction in turbulent times? One possible solution is to employ a systematic, disciplined approach that provides exposure to stocks with a built-in mechanism to shift to cash depending on market conditions.”

For example, the VictoryShares US 500 Enhanced Volatility Wtd ETF (CFO) shifts from a long position to cash position depending on market swings to help investors better manage risk exposure. When the ETF is less than 100% allocated in stocks, assets are invested in cash or 30-day T-bills. The reallocation process is rules-based and determined based on month-end index values.

Specifically, if on the last day of trading of the month the index declines 10% from its all-time high, the ETF will allocate to 75% cash and 25% stocks. If the index falls 20%, the ETF will hold 50% cash and 50% stocks. If the index falls 30%, it will hold 75% stocks and 25% cash. Lastly, if the index plunges 40%, it will hold 100% stocks.

“Our enhanced ETFs reduce exposure to the equity markets during periods of significant market declines, but they systematically reinvest in stocks after they fall precipitously. Each index has its own set of specific trigger points, determined by historical volatility for that market segment,” according to Victory Capital.

CFO’s indexing methodology aims to combine fundamental criteria and volatility weighting to outperform traditional passive strategies. The smart beta ETF may limit steep losses associated with protracted drawdowns and reallocate to stocks in times after prices have fallen, providing improved risk-adjusted returns over the long haul without an investor’s constant monitoring.

For more on smart beta ETFs, visit our Smart Beta Channel.

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