How Volatility Weighted ETFs Work

May 03, 2017

VictoryShares has 12 ETFs on the market today, with all but one using a volatility-weighting scheme that attempts to offer better diversification and risk management than competing strategies. Together, they command about $1.4 billion in assets.

The firm, still relatively new to the ETF space, last month launched its first nonvol-weighted ETF using an index co-developed with Nasdaq to capture dividend growers.

Mannik Dhillon, president of VictoryShares, walks us through the philosophy and methodologies behind these ETFs, and the firm’s commitment to pushing boundaries in the smart-beta ETF segment. Almost all of VictoryShares’ ETFs are volatility-weighted, the largest being the VictoryShares US EQ Income Enhanced Volatility Wtd Index ETF (CDC), with $435 million in assets. Why this approach?

Mannik Dhillon: Volatility weighting, very specifically, is not targeting low volatility as a selection mechanism. It’s a weighting mechanism to better diversify an index—to address the concentration that occurs in cap-weighted indices where a few stocks dominate the performance and the risk profile of the index.

If you think back to index design, the first answer the industry came up with to tackle that issue was equal weighting. That was a pretty good solution in diversification from cap weighting, but it introduces some other biases. For example, you weight more to the smaller companies in the index, which could be riskier.

The idea here is that if you use the volatility of a company’s stock price over the last 180 trading days, and basically inversely weight securities based on that metric—that the least volatile weights more—the most volatile stocks will still be in the portfolio. That's what makes it different from some of the very popular low-vol strategies. Do you compare these vol-weighted ETFs to other low-vol and minimum-vol strategies in the market, like the PowerShares S&P 500 Low Volatility Portfolio (SPLV) and the iShares Edge MSCI Min Vol USA ETF (USMV)?

Dhillon: No. I consider SPLV and USMV to be in a similar bucket, trying to drive a similar outcome. The question here is, what's the outcome you're trying to drive? In both those cases, you're trying to get a less volatile portfolio.

Our strategies don’t have a target or end objective of adjusting volatility at all. We’re simply saying that if you use volatility of a company as your weighting mechanism, you get better diversification across that list of securities.


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