I am pretty excited today, because I realised that an equal weight ETF (MarketVectors Equal Weight) has come to Australia (finally).
Why does this excite me? Lots of reasons:
1. Diversification - the benchmark index S&P ASX 200 covers 80% of the market cap of the ASX. The top 10 holdings account for ~50% of that size. So when you buy an index fund like STW, you are essentially buying the top ten stocks (by market cap) with half your money and the remaining 190 stocks with the other half.
To give you an idea of how bad the issue of concentration is on the ASX, if you look at the S&P ASX 300, which adds an additional 100 stocks to the universe, this only covers an additional 1% (i.e. 81%) of the market cap of the ASX.
The equal weight ETF does not suffer from this issue, and in fact has the "opposite problem" (which I will get to in the next point).
If you research quantitative finance a lot, you will find that diversification is often referred to as one of the few "free lunches" that can increase returns and reduce volatility.
The other well recognised free lunch is:
2. Rebalancing -
Rebalancing in the benchmark (market cap weighted) index is a passive outcome, the portfolio manager doesn't actually have to do anything except replace stocks which are no longer in the top 200 or 300 based on market cap. This can be equated to "sell your losers and buy your winners".
Rebalancing quarterly to equal rather than market weights renders an outcome which is the opposite of that. i.e. "sell your winners and buy your losers". Maybe this sounds like a counterintuitive thing to do, but as research has shown, this sort of rebalancing actually generates its own returns (see http://gestaltu.blogspot.com.au/2012/02/volatility-harvesting-and-importance-of.html).
So now we are at two free lunches! Great, but actually it gets better. Thanks to the diversification and rebalancing we also get:
3. Small Minus Big (SMB) factor exposure -
Rebalancing quarterly to equal weight means that the largest stocks in the portfolio are (at the beginning of each rebalancing period) given the same allocation as the smallest stocks. This naturally increases the SMB factor exposure of the portfolio, which over the long run should provide extra returns from the factor.
If you don't know much about SMB factor, you can find out a little bit here http://blog.alphaarchitect.com/2014/07/02/does-the-size-effect-exist/
4. High Minus Low (HML) aka "Value" factor exposure -
Rebalancing quarterly to equal weight means that the most expensive stocks in the portfolio are (at the beginning of each rebalancing period) given the same allocation as the cheapest stocks. This naturally increases the HML factor exposure to the portfolio, which, again, should provide extra returns from the factor.
If you don't know much about the HML factor you find out some stuff here http://blog.alphaarchitect.com/2015...-tools-to-understand-what-drives-performance/
To give you an idea of how all of the above might add up, I just quickly screenshot the ETF holdings (based on 31/05/15)
and compare that with STW
So, to me, that is awesome stuff to finally see the ASX offer investors what you can already get overseas in most other developed markets.
Other (less exciting but still tangible) benefits:
* The fund isn't actually a value or smallcap fund, it's "fundamentals agnostic" it just naturally heavier tilts towards small/value.
* Heavy exposure to market return factor (i.e. stocks return more than risk free assets)
* Some exposure to momentum factor (i.e. stocks in motion will continue to be in motion) between rebalancing periods.
* Management fee is not horrible (0.35).
* Buy/hold this ETF for factor exposure is much more tax, time and compounding friendly than manually running the portfolio yourself.
I personally look forward to seeing more ETFs like this come to the ASX, since it makes my life as an investor much easier. I would like to see a momentum ETF, and some value ETFs that aren't based on "high yield" stocks (there is the Russell Large Value, ETF which is good, but would be great to see a Small Value too). There is a minimum volatility ETF for US largecaps but they couldn't help themselves and had to make it "high yield" (ANZ ETFS S&P 500 High Yield Low Volatility ETF) which annoys me.
Why does this excite me? Lots of reasons:
1. Diversification - the benchmark index S&P ASX 200 covers 80% of the market cap of the ASX. The top 10 holdings account for ~50% of that size. So when you buy an index fund like STW, you are essentially buying the top ten stocks (by market cap) with half your money and the remaining 190 stocks with the other half.
To give you an idea of how bad the issue of concentration is on the ASX, if you look at the S&P ASX 300, which adds an additional 100 stocks to the universe, this only covers an additional 1% (i.e. 81%) of the market cap of the ASX.
The equal weight ETF does not suffer from this issue, and in fact has the "opposite problem" (which I will get to in the next point).
If you research quantitative finance a lot, you will find that diversification is often referred to as one of the few "free lunches" that can increase returns and reduce volatility.
The other well recognised free lunch is:
2. Rebalancing -
Rebalancing in the benchmark (market cap weighted) index is a passive outcome, the portfolio manager doesn't actually have to do anything except replace stocks which are no longer in the top 200 or 300 based on market cap. This can be equated to "sell your losers and buy your winners".
Rebalancing quarterly to equal rather than market weights renders an outcome which is the opposite of that. i.e. "sell your winners and buy your losers". Maybe this sounds like a counterintuitive thing to do, but as research has shown, this sort of rebalancing actually generates its own returns (see http://gestaltu.blogspot.com.au/2012/02/volatility-harvesting-and-importance-of.html).
So now we are at two free lunches! Great, but actually it gets better. Thanks to the diversification and rebalancing we also get:
3. Small Minus Big (SMB) factor exposure -
Rebalancing quarterly to equal weight means that the largest stocks in the portfolio are (at the beginning of each rebalancing period) given the same allocation as the smallest stocks. This naturally increases the SMB factor exposure of the portfolio, which over the long run should provide extra returns from the factor.
If you don't know much about SMB factor, you can find out a little bit here http://blog.alphaarchitect.com/2014/07/02/does-the-size-effect-exist/
4. High Minus Low (HML) aka "Value" factor exposure -
Rebalancing quarterly to equal weight means that the most expensive stocks in the portfolio are (at the beginning of each rebalancing period) given the same allocation as the cheapest stocks. This naturally increases the HML factor exposure to the portfolio, which, again, should provide extra returns from the factor.
If you don't know much about the HML factor you find out some stuff here http://blog.alphaarchitect.com/2015...-tools-to-understand-what-drives-performance/
To give you an idea of how all of the above might add up, I just quickly screenshot the ETF holdings (based on 31/05/15)
and compare that with STW
So, to me, that is awesome stuff to finally see the ASX offer investors what you can already get overseas in most other developed markets.
Other (less exciting but still tangible) benefits:
* The fund isn't actually a value or smallcap fund, it's "fundamentals agnostic" it just naturally heavier tilts towards small/value.
* Heavy exposure to market return factor (i.e. stocks return more than risk free assets)
* Some exposure to momentum factor (i.e. stocks in motion will continue to be in motion) between rebalancing periods.
* Management fee is not horrible (0.35).
* Buy/hold this ETF for factor exposure is much more tax, time and compounding friendly than manually running the portfolio yourself.
I personally look forward to seeing more ETFs like this come to the ASX, since it makes my life as an investor much easier. I would like to see a momentum ETF, and some value ETFs that aren't based on "high yield" stocks (there is the Russell Large Value, ETF which is good, but would be great to see a Small Value too). There is a minimum volatility ETF for US largecaps but they couldn't help themselves and had to make it "high yield" (ANZ ETFS S&P 500 High Yield Low Volatility ETF) which annoys me.
