VelocityShares Equal Risk Weighted Large Cap ETF (ERW): A Balanced Approach to Low Volatility Investing. December 2013

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1 VelocityShares Equal Risk Weighted Large Cap ETF (ERW): A Balanced Approach to Low Volatility Investing December 2013 Please refer to Important Disclosures and the Glossary of Terms section of this material.

2 Glossary of Terms Alpha: A measure of a stock s risk adjusted return in excess of the return expected for its market risk. Beta: A measure of a stock s risk relative to the risk of the overall stock market. A beta of less than 1 indicates a stock which is expected to have less risk than the broad market, and a beta of more than 1 indicates a stock which is expected to have more risk than the broad market. Beta-Adjusted SPX Option Volatilities: A method of estimating the volatility of a security by using the volatility of the S&P 500 Index and the Beta of the security to the S&P 500 Index. Capital Asset Pricing Model (CAPM): A theoretical model which calculates the expected return of a stock compared to the overall risk and return of the stock market. Correlation: A normalized statistical measure of how two securities move in relation to each other. Negative correlation is a relationship in which one security tends to increase as the other decreases, and vice versa. It does not mean they will always move in opposite directions without exception. Covariance: A statistical measure of how two securities move in relation to each other. Covariance Matrix: A statistical tool which includes the covariance of all securities in a portfolio. ERWSPX: The VelocityShares Equal Risk Weighted Large Cap Index (ERWSPX). Equal Weight Index: An index which holds an equal notional exposure in each component stock. Exponential Moving Average: A method of computing the average that is more heavily weighted by recent data, and less heavily weighted by older data. Implied Volatility: Is a measure of the expected risk of a security, which is derived from the prices of options on that security. Logarithmic (Log) Return: The continuously compounded rate of return. Low Beta Anomaly: The historical observation that often, low beta stocks have had higher risk adjusted returns than high beta stocks. Low Volatility Anomaly: The historical observation that often, low volatility stocks have had higher risk adjusted returns than high volatility stocks. Low Volatility Index: An index which weights its component stocks inversely to their volatility

3 Glossary of Terms (continued) Market Cap Weighting: An investing approach to weight an index or portfolio of stocks according to each stock s total market value, or market capitalization. Mean-Variance Efficient: A given portfolio is mean-variance efficient if it has the highest expected return for a given level of volatility among alternative portfolios. Modern Portfolio Theory: An academic theory that states investors are risk averse and should own diversified portfolios which reflect the overall stock market. Optimization: A computational technique which determines stock weights in a portfolio, subject to certain constraints. Risk Parity: A method of asset allocation in which each asset class is held such that it contributes an equal amount of expected risk to the overall portfolio. Sharpe Ratio: A measure of risk-adjusted returns. It is equal to the expected return of a stock or portfolio minus the risk-free rate and the difference is divided by the volatility of that stock or portfolio. Sortino Ratio: A measure of risk-adjusted returns. It is equal to the expected return of a stock or portfolio minus the risk-free rate and the difference is divided by the downside volatility of that stock or portfolio. SPX: The S&P 500 Index SPTR: The S&P 500 Index, total return S&P 500 Index: The Standard & Poor s composite index of 500 stocks, a widely recognized, unmanaged index of common stock prices. VelocityShares Equal Risk Weighted Large Cap Index (ERWSPX): An unmanaged index which weights eligible stocks from the S&P 500 Index such that each stock contributes the same amount of expected risk to the overall risk of the index. Vol: An abbreviation for volatility. Volatility: A statistical measure of the dispersion of returns, often used as a measure of risk

4 Equal Risk Weighting Overview Many investors are looking for an intelligent way to capture the low beta anomaly Any approach will need to balance this objective with a desire to avoid unnecessary individual stock risk Equal Risk Weight is a sophisticated solution which takes a balanced approach to low volatility investing

5 What is Equal Risk Weighting? Similar to Risk Parity approach to asset allocation Weight an equity index such that EACH COMPONENT STOCK has the same expected contribution to total portfolio risk For example, in a 10 stock Equal Risk Weight index with an expected annualized volatility of 10%, each stock would be contributing 1% to total portfolio risk A stock s contribution to total portfolio risk is a combination of its expected volatility AND its correlation to the rest of the portfolio

6 What is Equal Risk Weighting? ERWSPX S&P 500 SP5LVIT M00IMV$T ERWSPX VelocityShares Equal Risk Weighted Large Cap Index SPTR S&P 500 Total Return Index SP5LVIT S&P 500 Low Volatility Index M00IMV$T MSCI USA Minimum Volatility Total Return Index Past Performance is not a guarantee of future results. Index returns do not represent fund returns. Indices are unmanaged and one cannot invest in an index Annualized: ERWSPX SPTR SP5LVIT M00IMV$T Return % % 7.44% 9.02% Vol % % % % Sharpe Ratio Downside Vol 7.99% 8.21 % 7.59% 7.3 4% Sortino Ratio Beta Correlation Source: Bloomberg and VelocityShares Apr-13 through Nov-13 The inception date for the VelocityShares Equal Risk Weighted Large Cap Index ( ERWSPX ) is April 4, 2013 ERWSPX data is net of 65bps fees; fees are not removed from the other indices

7 Why Low Volatility Investing? The academic research on low volatility stocks is primarily about alpha, not about risk reduction! Academic basis Bill Sharpe s mean-variance framework and the Capital Asset Pricing Model led to the first Index fund in 1971*. In 1972 Black, Jensen, and Scholes published a paper** titled The Capital Asset Pricing Model: Some Empirical Tests They concluded that High-beta stocks have negative alpha s and lowbeta stocks have positive alphas. This has been called the low beta or low volatility anomaly. * **

8 Approaches to Index Weighting Market cap weighting is only mean-variance efficient under a theoretical model, whose assumptions are often violated in reality Historically low volatility stocks have had higher Sharpe ratios than high volatility stocks* Not all alternative weighting mechanisms are created equal, and often a low volatility approach creates concentrated stock and sector risk *See Black, Jensen, and Scholes (1972) and Baker, Bradley and Wurgler (2011)

9 Academic Basis of Market Cap Weighting The basis for market cap weighting a portfolio of stocks is Modern Portfolio Theory (MPT) originally proposed by Harry Markowitz in 1952 MPT assumptions include: All investors have the same risk and return expectations All investors invest based solely on the ratio of risk to return All investors can borrow and lend unlimited amounts at the risk free rate There are no taxes or transaction costs There are no investment opportunities other than those in the market cap index

10 It s all about the optimization! The mean-variance framework implies that one should attempt to maximize the expected return of a portfolio for a given amount of risk. The Capital Asset Pricing Model (CAPM) gives an innovative solution which says a market capitalization weighted portfolio will be mean-variance efficient But if there are ANY factors which can predict stock returns other than their volatilities, some alternative approach will be needed The low vol anomaly means many investors are considering ways to tilt their portfolio towards low beta stocks But investors want to avoid stock-specific return forecasting Equal risk weighting does not require any return expectations, only a covariance matrix

11 Possible Alternatives to Market Cap Weighting Market Cap Weighting Characteristics: Weights all stocks by total market value High weight concentration Overweight in overvalued stocks High risk concentrations Equalize weights, ignore volatility Incorporate volatility, ignore correlation Low Vol Weighting Characteristics: Weights all stocks by individual risk Lower weight concentration Overweight in low risk stocks Erratic risk concentrations Incorporate volatility AND correlation Equal Weighting Characteristics: Weights all stocks equally Eliminates concentration High risk in volatile stocks Equalize risk, incorporate weights AND volatilities Equal Risk Weighting Characteristics: Weights all stocks equally by total risk Lower weight concentration High weight in low risk stocks

12 Index Weighting Variation Hypothetical weights of the top ten stocks in a 500 stock Index 1, with 4 alternative weighting mechanisms 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% Market Cap $ Weight Risk Weight 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Low Vol $ Weight Risk Weight High concentration in large cap stocks, with unpredictable risk concentrations 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Equal Weight $ Weight Risk Weight 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Overweights low risk stocks, but has erratic total risk weights, potentially high risk concentrations Equal Risk Weight $ Weight Risk Weight Eliminates concentration, but overweights risky stocks Overweights low risk stocks, eliminates risk concentrations Source: VelocityShares 1 The 500 stock sample is for illustrative purposes only, and does not represent any given portfolio or index. Dollar and risk weights of the actual portfolio may vary from the information displayed

13 VelocityShares Equal Risk Weighted Large Cap Index ( ERWSPX Index )

14 ERWSPX Index Summary The ERWSPX Index uses an optimization process to assign equal risk weighting to each eligible component stock of the S&P 500 Index. Does not use stock specific return forecasts. Combines historical and implied volatilities. Is rebalanced quarterly to weight each stock so that expected contribution to overall portfolio risk is equalized across all stocks. Overweights low volatility stocks, while attempting to reduce stock and sector specific risks

15 ERWSPX Index Construction Process The Eligible Universe includes S&P 500 stocks with at least 8 months of data. Two optimizations are run: Historical Optimization Calculate historical covariance matrix using six months of exponential moving average returns Forward Implied Optimization Calculate implied covariance matrix using beta adjusted SPX option volatilities and six months of log returns Optimize for Equal Risk Weight Optimize for Equal Risk Weight The results of the two optimizations are blended to create final index weights, subject to a maximum index market cap weighting of 3% for any constituent

16 Index Performance: April 2013 to Present ERWSPX S&P 500 SP5LVIT M00IMV$T ERWSPX VelocityShares Equal Risk Weighted Large Cap Index SPTR S&P 500 Total Return Index SP5LVIT S&P 500 Low Volatility Index M00IMV$T MSCI USA Minimum Volatility Total Return Index Past Performance is not a guarantee of future results. Index returns do not represent fund returns. Indices are unmanaged and one cannot invest in an index Annualized: ERWSPX SPTR SP5LVIT M00IMV$T Return % % 7.44% 9.02% Vol % % % % Sharpe Ratio Downside Vol 7.99% 8.21 % 7.59% 7.3 4% Sortino Ratio Beta Correlation Source: Bloomberg and VelocityShares Apr-13 through Nov-13 The inception date for the VelocityShares Equal Risk Weighted Large Cap Index ( ERWSPX ) is April 4, 2013 ERWSPX data is net of 65bps fees; fees are not removed from the other indices

17 Index $-Weight Breakdown by Sector as of November 30, 2013 Significantly Less Sector Concentration than the S&P 500 Low Volatility Index (SP5LVIT) Highest 3 Sectors Hold Approximately 46% v. 60% in the SP5LVIT Index Largest Differential between SPX and ERWSPX is Overweight Utilities Approximately 6% Largest Differential between SPX and the SP5LVIT Index is 21% Overweight Utilities 30% 25% Dollar Weights by Sector 20% 15% 10% 5% 0% Con Disc. Con Staples Energy Financials Health Care Industrials Tech Materials Telecom Utilities ERWSPX SPX SP5LVIT Source: PowerShares, Bloomberg, S&P Nov

18 Equal Risk Weighting Conclusion Many investors are looking for an intelligent way to capture the low beta anomaly Any approach will need to balance this objective with a desire to avoid unnecessary individual stock risk Equal Risk Weight is a sophisticated solution which takes a balanced approach to low volatility investing

19 IMPORTANT DISCLOSURES An investor should consider the investment objectives, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus containing this and other information, please call or download the file from Read the prospectus carefully before you invest. Past performance does not guarantee future results. RISKS: There are risks involved with investing, including possible loss of principal. Please see the relevant prospectus for a discussion of risks. The funds have limited operating history. Investing in the VelocityShares Equal Risk Weighted Large Cap ETF (the "ERW ETF") involves risks related to strategy, volatility as a measure of risk, index methodology limitations, concentration risk, performance risk, rebalancing frequency limitations, fixed algorithmic model parameters, and optimization model precision. There is no guarantee that the methodology employed by the ERW ETF will maximize returns or minimize risk. Neither the ERW ETF nor ETC, the Adviser, can offer assurances that tracking the Index will maximize returns or minimize risk, or be appropriate for every investor seeking a particular risk profile. Index returns do not represent fund returns. The fund is considered non-diversified, which means the fund invests in a limited number of issuers and may be more susceptible to a single adverse economic or regulatory occurrence. The funds are not insured by the FDIC; are not guaranteed bank deposits; and are subject to investment risks, including the possible loss of principal. Ordinary brokerage commissions apply. Shares are not individually redeemable. Investors buy and sell shares of ERW ETF on a secondary market. Only Authorized Participants may trade directly with the ETF, typically in blocks of 50,000 shares. Exchange Traded Concepts, LLC ("ETC") serves as the investment advisor to the ERW ETF. The ERW ETF is distributed by SEI Investments Distribution Co. ("SIDCO"), which is not affiliated with ETC or any of its affiliates. Neither ETC or SIDCO are affiliated with VelocityShares. VelocityShares, the VelocityShares logo, the VelocityShares Equal Risk Weighted Large Cap Index are trademarks of VelocityShares Index & Calculation Services, a division of VelocityShares, LLC. Neither VelocityShares Index & Calculation Services, VelocityShares, LLC (together, VelocityShares ) nor any other party makes any representation or warranty, express or implied, to the owners of any securities which may be linked, or which may be valued with reference to, any VelocityShares index, or members of the public regarding the advisability of investing in such securities generally or the similarities or variations between the performance of the index and the performance of such underlying securities. VelocityShares is the licensor of certain trademarks, service marks and trade names of VelocityShares LLC and of certain Indices, which are determined, composed and calculated by VelocityShares without regard to the issuer of the any securities which may be linked to such indices. Neither VelocityShares nor any other party guarantees the accuracy and/or the completeness of the indices or any date included therein. VelocityShares disclaims all warranties of merchantability or fitness for any particular purpose with respect to the indices or any data included therein. Nothing herein constitutes a solicitation, offer or recommendation by VelocityShares or its affiliates to buy or sell securities. VelocityShares does not render investment, tax, accounting or legal advice. Investors should review the prospectus for each security and make their own investment decisions based on their specific investment objectives and financial position and after consulting independent tax, accounting, legal and financial advisors. The VelocityShares Equal Risk Weighted Large Cap Index (the Index ) is the exclusive property of VelocityShares Index & Calculation Services (the Licensee ), which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) ( S&P Dow Jones Indices ) to calculate and maintain the Index. The S&P 500 index is the property of S&P Dow Jones Indices and/or its affiliates and has been licensed by S&P for use by Licensee in connection with the Index. S&P is a registered trademark of Standard & Poor s Financial Services LLC ( SPFS ); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC ( Dow Jones ); and, these trademarks have been licensed to S&P Dow Jones Indices. Calculated by S&P Dow Jones Indices and its related stylized mark(s) have been licensed for use by Licensee. Neither S&P Dow Jones Indices, SPFS, Dow Jones nor any of their affiliates sponsor and promote the Index and none shall be liable for any errors or omissions in calculating the Index. The VelocityShares Equal Risk Weighted Large Cap ETF (the ETF ) is not sponsored, endorsed, sold or promoted by S&P, its affiliates or their third party licensors and neither S&P, its affiliates nor their its third party licensors make any representation regarding the advisability of investing in the ETF