VelocityShares is best known for its wide lineup of leveraged and inverse products. The company has a host of commodity ETNs that utilize leverage, while it also has a suite of VIX products as well.
While the firm has seen some success with this strategy, it is also looking to branch out into the unlevered equity market as well. This is best evidenced by an innovative filing that the company just released to the SEC targeting large cap stocks.
This new filing, which is for the VelocityShares Equal Risk Weighted Large Cap ETF , looks to focus on the biggest American equities, but with a twist. Instead of just weighting by market cap level or equally weighting across the board, this innovative product is seeking to utilize an equal risk weighting scheme instead.
ERW in Focus
This approach looks to target all 500 stocks in the S&P 500 in a way that ensures that each stock contributes an equal amount of risk to the overall index. This will be based on historic price movements/co-movements as well as implied market price volatility and each stock’s price sensitivity to market price variations (see Buy These ETFs for Higher Returns and Lower Risk).
According to the filing, “A proprietary optimization model then seeks to weight each stock according to each of the two volatility factors separately, such that the expected risk contribution of a constituent stock in the Index is equal to the risk contribution of each other constituent stock in the Index.”
The filing continues by stating that the '“risk contribution” of a constituent stock is defined as the sensitivity of the volatility of all of the Index constituents collectively to a change in the risk weighting of an individual constituent. The resulting weights from each optimization are then averaged to determine the weight for each constituent.'
Investors should also note that the product will also be capping each individual stock’s weight at 10% in order to insure decent diversification. Risk weightings and index rebalancings are done on a quarterly basis, and all of this looks to be done for a surprisingly low fee of 65 basis points a year (see Three Excellent Dividend ETFs for Safety and Income).
What does it all mean?
This could be a brand new approach to weighting securities that may offer up a more risk-focused holdings pattern. It remains to be seen though, what this means in terms of individual security weights, and which sectors are heavily allocated to.
Still, if this approach can offer up some outperformance when compared to more traditional models, it could see some inflows. It could also be of interest if investors are scared about a few securities dominating the risk return outlook of a particular ETF, as this proposed fund may be an interesting play to mitigate these worries (see Are There Really High-Dividend, Low Risk ETFs?).
There isn’t much competition to this type of product on the market today, as most ETFs focus on market cap weighting or various other approaches like equal, revenue, or dividend weighting. These have seen varying degrees of success though, as some have not been embraced as readily as others.
In particular, ETF investors have shown great interest in dividend focused weighting systems, such as those that make up products like (DVY - ETF report) or (SDY - ETF report). There has also been a great deal of interest in pure dividend weighting, as seen in many of WisdomTree’s funds like (DLN - ETF report) (see Time to Buy This Top Ranked Dividend ETF?).
Beyond that, investors have also shown a great deal of interest in ETFs that have a low volatility focus. These include billion dollar funds like (SPLV - ETF report) and (USMV - ETF report), while several more have hundreds of millions in invested capital.
This heavy focus on low volatility does suggest that there could be some interest in VelocityShares’ ETF if it is able to ever hit the market. The test will be if the company can pass the regulatory hurdles and if investors are willing to pony up a little more in fees for this innovative and potentially superior weighting methodology.
If that is the case, this could be a solid start for VelocityShares in their new quest to break into the unleveraged ETF world.
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