When the VIX spiked suddenly earlier this year, there was carnage among a few ETFs that were betting against volatility. That created confusion among the array of products that reference the word “volatility” in their name or marketing. Indeed, not all ETFs with volatility in the name are equal. VictoryShares maintains that investors can benefit from understanding that investing in volatility and volatility-weighting are not remotely similar.
“You hear people talking about products that are long-vol, short-vol, low-vol, minimum-vol and volatility-weighted,” said Mannik Dhillon, President of VictoryShares. “They all use the same word, but ‘volatility’ has vast meaning and can be measured and used in different ways.”
Dhillon highlighted that the products that ran into issues during February were actually trying to give people exposure to volatility as measured by the VIX, or more specifically, short exposure.
“But not all ETFs that mention volatility are buying or selling it,” he says. “There are low-vol and minimum-vol ETFs, which use volatility to describe the risk profile of the index or portfolio,” he said. “VictoryShares, on the other hand VictoryShares uses volatility in a different way, to weight securities with the intended outcome being diversification.”
Related – Volatility: A Rose By Any Other Name
As market swings grow more volatile, investors may look to smart beta ETFs that help reduce the negative effects of severe market oscillations.
For example, Victory Capital offers a suite of smart beta ETFs that focus on volatility-based weighting methodology to potentially help investors generate improved risk-adjusted returns.
The VictoryShares US 500 Enhanced Volatility Wtd ETF (CFO), VictoryShares US EQ Income Enhanced Volatility Wtd ETF (CDC) and VictoryShares US 500 Volatility Wtd ETF (CFA) start with the broad market and screens for companies with four quarters of positive earnings. Those stocks are then weighted based on their standard deviation over the past 180 trading days. Stocks with lower volatility are given higher weightings and stocks with greater volatility are given lower weightings. Ultimately, all securities that pass the earnings criteria are present, just at different weights.
“Historical volatility, not implied or expected volatility, simply drives to how stocks are weighted in the portfolio (vol-weighting), which is done in an effort to improve diversification benefits and, potentially, for downside mitigation. For VictoryShares, vol-weighting simply takes a historical statistic—standard deviation—and uses it to weight a particular basket of stocks. It is not an implied view of where overall market volatility is going based on a derivative product, as with some of these other leveraged ETPs,” according to Victory Capital.
In an attempt to help investors keep emotions in check, the firm offers long/cash ETFs as well that follow a rules-based strategy that shifts from a long position to 75% cash position depending on market swings to help better manage risk exposure. When the ETFs are less than 100% allocated in stocks or bonds, assets are invested in cash or 30-day T-bills. The reallocation process is strictly rules-based and determined based on month-end index values allowing for the potential to dollar cost average back into the market when emotions might make it difficult to do so otherwise.
Looking at CFO, 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.
For more information on alternative index-based strategies, visit our Smart Beta Channel.