VelocityShares is best known for its lineup of inverse and leveraged products which give investors concentrated exposure to a number of volatile commodities like natural gas, platinum, and crude oil. The company has started to expand out to ‘regular’ products too though, focusing on hedging and emerging markets for this new part of its ETF lineup.
The latest addition to this trend looks to focus on the U.S. market instead, holding large and mid cap stocks, pretty similar to the S&P 500. However, this new ETF looks to hold stocks in very different proportions than the popular benchmark, utilizing risk as the main weighting component instead of market capitalization (also see Overweight These Equal Weight ETFs in Your Portfolio).
Below, we highlight some of the key details regarding this product for those who are looking for a different—and potentially superior—way to target the U.S. market in ETF form:
New VelocityShares ETF in Focus
The new product will trade under the name of the Equal Risk Weighted Large Cap ETF (ERW), holding about 500 stocks in its basket. The product will charge investors 65 basis points a year in fees and will look to follow the VelocityShares Equal Risk Weighted Large Cap Index.
This benchmark seeks to measure a stock’s risk and then weight the exposure to each stock in the index so that each company contributes the same level of risk. In this way, lower expected risk stocks will take up a bigger portion of the VelocityShares benchmark, at least when compared to the S&P 500 (see 3 ETFs with Incredible Diversification).
Top components of the index include CME Group, Monster Beverage, and Spectra Energy, and the three combine to hold roughly 11% of the assets in the benchmark. This contrasts immensely with the S&P 500, as that benchmark has Apple, Exxon, and Johnson & Johnson as its top three, with the trio combining to take up less than 7.4% of the total.
In terms of sectors, ERW looks to be overweight—compared to products like SPY—in health care, utilities and consumer sectors. Meanwhile, the fund will be underweight in segments such as energy, technology, and financials. Overall the top segment looks to be health care, with telecom and materials lagging for allocations.
How does this fit in a portfolio?
This product appears to be an appropriate full market substitution for investors seeking broad exposure across a number of sectors. It also looks to be a solid choice for investors who are tired of cap weighted products, but do not believe in the merits of other alternative strategies like equal weight or low volatility (see Time to Invest in Low Volatility ETFs?).
Plus, equal risk weighting, according to Velocity Indices research, is the only one of the group that takes in to account correlation in order to determine market weight. This technique looks to help keep portfolio volatility low while ensuring that no single security will blow up the portfolio.
On the other hand, the product may not be appropriate for low cost-focused investors as it is far more expensive than both market cap weighted funds, and many of the most popular equal-weight ETFs on the market. Additionally, the low assets and lack of volume may produce wide bid ask spreads for the product, at least initially.
Arguably the biggest competitors to this ETF look to come to us in the equal weight and low volatility market. The most popular ETFs in these segments include the Guggenheim S&P Equal Weight ETF (RSP) and the PowerShares S&P 500 Low Volatility Portfolio (SPLV).
These two both have more than $4 billion in assets under management and generally do more than one million shares of volume a day. Plus, they both have at least a few years worth of a head start in accumulating assets so it may be difficult for a newcomer to find a niche (read Alternative ETF Weighting Methodologies 101).
However, if you believe the research on the equal risk weighted technique and its promise to be a superior weighting methodology, this new product could be the fund for you. It looks to have a more spread out risk profile, so investors who are worried about a few securities destroying their return may want to consider this ETF over some of its more entrenched peers for broad market exposure at this time.
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Author is long RSP