These days, there’s plenty of risks baked into U.S. large caps due to the coronavirus outbreak, but some ETFs can reduce that risk, including the Nationwide Maximum Diversification U.S. Core Equity ETF (NYSEArca: MXDU).
The Maximum Diversification U.S. Core Equity ETF tries to reflect the performance of the TOBAM Maximum Diversification USA Index, a diversified rules-based index of large- and mid-sized U.S. companies that uses a quantitative model to weight companies to maximize the so-called Diversification Ratio of the index. The Diversification Ratio is a proprietary metric based on the volatility of each index constituent and its correlation to other constituents.
MXDU creates a neutral risk allocation with the goal of generating superior risk-adjusted returns relative to cap-weighted large-cap strategies. The Nationwide ETF holds 467 stocks with an average market value of almost $34 billion and Tesla (NASDAQ: TSLA) is the largest holding at a weight of 2.42%.
Healthcare and consumer staples names combine for over 37% of MXDU’s weight, defensive that’s fruitful in today’s volatile climate.
MXDU’s benchmark begins with a group of large- and mid-cap companies screened against a socially responsible investment exclusion blacklist to exclude those involved with the production or sale of unconventional weapons, production of tobacco, production of coal or coal-based energy, serious or systematic human rights violations, severe environmental damage, gross corruption, or other particularly serious violation of ethical norms. The index then analyzes the volatility and correlation of each component and weights them to maximize the Diversification Ratio.
The top 500 equity securities by market-cap are taken and are then subjected to a marginal risk contribution calculation based on the security’s volatility and correlation to other securities for the past year. Securities are then ranked by marginal risk contribution, and 50% of those with the lowest marginal risk contribution are selected.
To the point of diversification, the TOBAM index that servers MXDU’s benchmark “constructs a portfolio with equal and lowest possible correlation among individual holdings,” according to Nationwide, meaning one bad apple won’t spoil the bunch in this fund.
The equally-weighted risk contribution methodology incorporates each constituent’s volatility and correlation to the other constituents for the past year to create a portfolio where each holding contributes the same level of risk, which should produce lower overall volatility of the index, a higher risk-adjusted return and diminish maximum drawdowns.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.