Vinit Srivastava: A managed risk strategy, as proxied by S&P’s Managed Risk 2.0 Indices will seek to decrease equity market exposure – while reallocating to less risky assets – as portfolio volatility increases to predetermined levels. While this means not participating fully in select directionally positive days for equities, in the past the strategy has proved to be beneficial by losing less and decreasing volatility, and therefore unpredictability, in returns and portfolio values.
Tom Lydon: Tell us about the index series these DeltaShares Managed Risk ETFs track?
Vinit Srivastava: We believe this is a groundbreaking index series for S&P Dow Jones Indices and the indexing industry. The S&P Managed Risk 2.0 Index series, designed and published in collaboration with Milliman FRM, represents an evolution of our original S&P Managed Risk Index series. That series, launched in 2015, was built to help investors measure the benefits of a managed risk approach and provide a benchmark for this growing segment.
Each 2.0 Index is designed to simulate a dynamic portfolio that both aims to manage volatility and seeks to limit losses stemming from equity exposure. They are constructed using three underlying indices – a select market-cap weighted S&P equity index, the S&P U.S. Treasury Bond Current 5-Yr Index and the S&P U.S. Treasury Bill 0-3 Month Index. The 2.0 indices feature a dynamic allocation mechanism that is rules-based. When *realized annualized volatility is below a predetermined target level of 22%, the given 2.0 Index will allocate 100% to the related equity index. When volatility increases and approaches or exceeds the limit, the 2.0 indices will reduce the allocation to the underlying equity index and steer toward 5-Year Treasuries and/or cash equivalents. The specific allocation between Treasuries and cash equivalents is based on the current yield spread between the two; when the yield on the Treasury index is sufficiently higher than the yield on the T-Bill index to justify the additional level of risk, the given 2.0 index will allocate to the 5-Yr Treasury index. Lastly, in seeking to limit losses, the 2.0 series methodology replicates a put option on each Index to help further reduce equity exposure. The construction methodology is extremely rigorous and was tested extensively by my team and our Index Committee. The 2.0 series are rebalanced and published daily for full transparency.
Tom Lydon: The indices sound rather sophisticated. How closely does DeltaShares seek to track the indices?
Tom Wald: While the indices may appear sophisticated, the investment objective is quite basic, strive for equity participation in rising markets and seek to take less downside risk in volatile times, when markets typically fall the most. In seeking to accomplish this, DeltaShares will be working to ensure we can track the underlying indices as closely as possible with an aim to achieve that objective.
Tom Lydon: Is it fair to categorize these ETFs as smart or strategic beta?
Tom Wald: Yes, we think the market will likely categorize DeltaShares as smart beta, however within that space we really do view DeltaShares as highly differentiated.
Vinit Srivastava: The equity indices within each ETF’s underlying S&P Managed Risk 2.0 index are market cap weighted, and are amongst the most tracked within their respective segments – the S&P 500, S&P MidCap 400, S&P SmallCap 600 and S&P EPAC Ex. Korea LargeMidCap. But the dynamic fluctuation of the equity level and the resultant allocation to the S&P U.S. Treasury Bond Current 5-Year Index and/or the S&P U.S. Treasury Bill 0-3 Month Index during periods of market stress means the ETFs aren’t simply tracking the underlying equity index and may behave differently when realized volatility is elevated.
Tom Lydon: How is this different from other smart beta category approaches? For instance, what is the difference between what DeltaShares is offering and the very popular low volatility ETFs that have gathered a lot of assets in the past couple of years?
Tom Wald: Low volatility products generally remain 100% in equities and may not offer other asset classes to help deliver their strategies. In the case of DeltaShares, we are applying a different type of approach that utilizes the correlation between market volatility and equity prices as well as the potential optimal combination of stocks and treasury bonds. This is different from low volatility ETFs which look to stay entirely invested in equities through a collection of stocks with historically low volatility, and which may not actually be specifically designed to contain volatility from a portfolio perspective. In other words, low volatility strategies take a stock-by-stock approach and remain entirely in equities. Managed Risk takes a portfolio perspective and can diversify to other asset classes.
Tom Lydon: Thank you, gentlemen.