Arch Indices has launched its debut exchange traded fund today that seeks to meet long-term investment goals while minimizing volatility. The Arch Indices VOI Absolute Income ETF (NYSE Arca: VWI) is a multi-asset fund targeting dividend stocks and bond ETFs.
VWI tracks the Arch Indices VOI Core Absolute Income Index. The index typically comprises 60 to 100 equity securities and up to 12 bond ETFs. Its holdings are weighted to maximize income while simultaneously minimizing volatility. Arch uses its “Variance Optimized Indexing” (VOI) methodology to weight each security by considering its yield, volatility, and correlation to the portfolio.
Building an Optimized Portfolio
VWI seeks to benefit from the capital appreciation potential of quality dividend-paying stocks, combined with the potential for volatility reduction provided by fixed income ETFs. Minimizing volatility provides a key source of liquidity in the event of an equity risk-off scenario through reduced drawdowns. The resulting portfolio is designed to deliver a goal-focused income solution with effective volatility reduction.
Arch Indices Co-Founder and CEO Yang Tang said constructing this fund has been a “passion project” for him and fellow co-founder Jinghua “Jacob” Kuang. “We want to build an optimized portfolio,” Tang told VettaFi.
“We wanted to build a product that gives [investors] a goal,” he added. “60/40 is a great idea, but why is it always 60-40 every year? So, we decided to build something dynamic.”
Bypassing the Limits of Passive and Active
Tang explained that while VWI is a rules-based index fund, there are “limitations of the current generation of passive. There’s some equal weight, there’s some inverse ranks. But it’s pretty limiting.”
When discussing passive ETFs in the market, he said that most of these products tend to have two major issues. “They’re very market-exposure-centric, and they’re not well-designed,” Tang explained. “We’re taking into account how stocks and bonds move together.”
And while passive does have its constraints, he noted that active has its own issues: “We don’t really like active. Active creates a lot of errors. We like rules-based transparent approach.”
So, VWI seeks to bypass the passive management’s limits while reducing the chance of human error found within active funds.
“Through this approach, we aim to deliver investors an optimized alternative to the static asset allocation models they have for too long been forced to choose from,” Tang said.
The VOI Approach
To be eligible for inclusion in the Index, equity securities must meet a number of requirements. They must have a market cap of at least $2 billion, minimum daily average trading volume, and a minimum 3% dividend yield. They must also have a five-year track record of regular dividend payments. Bond ETFs are chosen based on a range of factors, including their historical correlation to equities.
VWI then weights all eligible securities, first by sector into subindexes, and again using the VOI approach in the main index. The ETF dynamically rebalances quarterly to reflect changing market conditions and is optimized for income.
“Arch is a new ETF entrant, but its approach is unique in a crowded marketplace,” said VettaFi’s head of research Todd Rosenbluth. Blending dividend-paying stocks with fixed income ETFs provides risk reduction in a different manner.”
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