Investors who are concerned about concentration risks associated with the traditional market capitalization-weighted indexing approach may consider alternative index strategies, such as volatility-weighted smart beta exchange traded funds that help limit potential drawdowns.

“The drivers of the market have really been concentrated in a handful of stocks. We’re hearing a lot of advisors talk about the ‘FAANG’ exposures – those stocks that makeup 18% of the index, drove 800 basis points of return last year. When they’re trying to allocate to sort of a core allocation, that concentration comes with benefits when they’re working – that could become headwinds should they fail,” Scott Kefer, Senior Portfolio Strategist, Victory Capital, said at the Inside ETFs conference.

“So, we’re seeing a lot of success in our flagship volatility weighted approach to offering core broad market exposure,” he added.

For instance, 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.

The VictoryShares volatility weighted approach should not be confused with low-vol strategies, which are designed to capture excess returns to stocks with lower-than-average volatility, beta, and/or idiosyncratic risk.

While low-vol ETFs may only hold companies that tend to exhibit smaller swings using the factor as a selection, the VictoryShares suite starts 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. The weightings are based on volatility, so you end up with a more balanced and risk-aware approach to investing in the broad market.

Watch Scott Kefer Discuss Volatility-Weighted ETFs:

For more ETF-related commentary from Tom Lydon and other industry experts, visit our video category.

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