Today Principal is rolling out a low-cost smart-beta fund that offers lower-volatility exposure to the largest U.S. stocks. The Principal U.S. Mega-Cap Multi-Factor Index ETF (USMC) targets the largest companies in the Nasdaq US 500 Large Cap Index.
USMC comes with an expense ratio of 0.12% and lists on the Nasdaq stock exchange.
Companies eligible for inclusion fall into the top half of the parent index in terms of size, with the market capitalization of components as of late September ranging from $83.9 billion to $784.6 billion, according to the prospectus. At the end of September, the index included a total of 53 companies.
“Think of it as a pure definition of what a mega-cap is,” said Paul Kim, Principal’s managing director of ETF strategy.
“We think there’s a separate category for the mega-caps, and we think they behave differently than [the rest of the large-cap space],” he added, noting that the fund’s portfolio offers a combination of well-known brands, the “bluest of blue chip” names, strong balance sheets and long history.
“When you’re allocating to those names, you expect it to be liquid, you expect it to be high quality, high profitability—almost a relatively de-risked part of your equity budget compared to your midcaps, small-caps and certainly your international equities,” Kim added. “In that context, if you take it and then further tilt it toward low vol, it becomes much more of a way to get your equity allocation with fewer concerns about liquidity risk, and fewer concerns about downturns in markets relative to the other equity in your portfolio.”
The methodology relies on a two-tiered weighting approach. Those components falling into the top 10% in terms of size are weighted purely by market capitalization. However, the remaining components are equal-weighted, with an adjustment applied that gives less volatile and more liquid stocks more weight relative to the less liquid, more volatile stocks in the index.
“We left a slice of this portfolio market-cap-weighted. That way, you’re not structurally underweight the greatest momentum stocks—like Apple, Google and Amazon—that are on their way up,” he noted.
Kim further points out that because the fund’s index does not select stocks based on volatility but rather weights them based on their volatility, it has a slightly different set of names than a typical low-volatility fund. Beyond that, he says the fund offers true mega-cap exposure, a defensive equity allocation, a relatively similar yield to U.S. large-caps and a much lower risk profile for better risk-adjusted returns.
“We think it’s a very efficient way to get that exposure, and it allows you to take more risk in either higher-octane sectors or active strategies—places where you’re more likely to earn true alpha—than to spend your capital in a very efficient and very liquid part of the investment world,” he said.
The fund is the cheapest ETF to be offered by Principal by far, with the closest existing fund coming in at an expense ratio of 0.29%, and USMC is also near the bottom in terms of pricing for smart-beta funds. State Street offers the cheapest low-volatility ETFs, with the $85 million SPDR SSGA US Large Cap Low Volatility Index ETF (LGLV) also priced at 0.12%.
“With this pricing, we’re signaling we think this a core equity holding, and that we want to be aggressive and compete with the existing ETFs that provide large-cap equity exposure,” Kim added.
Columbia Adds Multisector Bond ETF
Today Columbia Threadneedle has rolled out an ETF that will offer exposure to six debt market sectors based on yield, quality and liquidity. The Columbia Diversified Fixed Income Allocation ETF (DIAL) tracks the Beta Advantage Multi-Sector Bond Index.
It lists on the NYSE Arca exchange and comes with an expense ratio of 0.28%.
The underlying index allocates 10% of its weight to U.S. Treasury securities, 10% to non-U.S. Treasury securities, 15% to domestic agency mortgage-backed securities, 15% to U.S corporate investment-grade bonds, 30% to domestic junk bonds and 20% to emerging markets sovereign and quasi-sovereign debt, according to the prospectus.
Each of the six sector index models making up the main index has its own parameters for security selection and weights its components by market value, with exclusion of the non-U.S. Treasury securities, which are equally weighted.
The sector subindexes range in scope from 11 securities to 474 securities, and the broad index includes a total of 831. However, the fund uses a sampling strategy to track its index, and the prospectus notes it will more typically hold approximately 125 securities.
The index and its subindexes are reconstituted and rebalanced monthly, the prospectus said.
Contact Heather Bell at [email protected]