Some low volatility ETFs are disappointing investors. They may want to consider the Nationwide Risk-Based U.S. Equity ETF (NYSEArca: RBUS).
RBUS “eliminates the 50% of the stocks in the universe that represent the riskiest positions in the portfolio” and the “weights the remaining stocks by their volatility and correlation such that each security contributes the same amount of risk to the portfolio,” according to Nationwide.
RBUS features some departures relative to rival low volatility ETFs. For example, the fund’s 16.86% weight to utilities is underweight that of the S&P 500 Low Volatility Index and the Nationwide ETF has no real estate exposure, but it does devote 29% of its combined weight to financial services and healthcare stocks.
Looking at RBUS
The low-volatility ETFs are factor-based strategies that tilt toward companies with a propensity for lower volatility. Different issuers and index providers arrive at a basket of low volatility stocks in varying fashions. Historical data confirm that over long holding periods, the low volatility factor is rewarding for investors.
Low-volatility factor investments work on the idea that they help cushion against market turns, limiting drawdowns that investors experience while providing upside potential. Consequently, the low- or min-vol strategies may produce better risk-adjusted returns over the long haul, which has been backed by extensive academic research.
Traditional market capitalization-weighted indexing methodologies pose hidden risks in a prolonged bull market environment. Alternatively, investors may look to smart beta or rules-based index ETF strategies that may limit these risks and potentially help enhance returns.
The Risk-Based U.S. Equity ETF will try to reflect the performance of the Risk-Based US Index, a rules-based, equal risk-weighted index designed to provide exposure to U.S. large-cap companies with lower volatility, reduced maximum drawdown and improved Sharpe ratio, compared to a traditional market cap-weighted index.
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.
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.