VelocityShares Equal Risk Weight ETF (ERW) Please refer to Important Disclosures and the Glossary of Terms section at the end of this material.

Transcription

1 VelocityShares Equal Risk Weight ETF (ERW) Please refer to Important Disclosures and the Glossary of Terms section at the end of this material.

2 Glossary of Terms Beta: A measure of a stocks 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 calculation of a stocks expected volatility which is calculated by mutiplying the implied volatility of SPX options the stocks beta to the SPX. Correlation: A 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 in which includes all covariance's of all securities in a portfolio Exponential Moving Average: A calculation of average returns which assigns a higher weight to more recent returns and a lower weight to less recent returns Implied Volatility: Is a measure of the expected risk of a security, which is derived from the prices of options on that security Log Returns: a mathematical calculation of a stocks return which is determined using a natural logarithm. It reflects the continually compounded return of the stock Low Beta Anomaly: The historical observation that often, low beta stocks have had higher risk adjusted returns than high beta stocks Market Cap Weighting: An investing approach to weight an index or portfolio of stocks according to each stocks 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 Optimization: A computational process where stock weights are determined to meet a specific goal, such as maximizing portfolio expected return, minimizing portfolio expected risk, or equalizing each stocks contribution to portfolio risk Sharpe Ratio: A measure of risk adjusted returns, it is the expected return of a stock or portfolio, minus the risk free rate, and divided by the volatility of that stock or portfolio. SPX: The S&P 500 Index 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 (ERW): an unmanaged index which weights eligible stocks form the S&P500 Index such that each stock contributes the same amount of expected risk to the overall risk of the index Volatility: a measure of stock or index risk that reflects the amount of variability in returns

3 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

4 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 * Black, Jensen Scholes (1972) and Baker, Bradley and Wurgler (2011)

5 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 says that investors should consider a stock s return relative to its risk, and then construct a portfolio of stocks that maximizes the portfolio s expected return relative to its risk. Ultimately, this leads to the concept of investing in market cap weighted portfolios. 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

6 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 Eliminates expected risk concentrations (All stocks have equal risk contribution)

7 Weight Weight Weight Weight Index Weighting Variation Hypothetical weights of the top ten stocks in a 500 stock sample¹, with 4 alternative weighting mechanisms 6.0% 5.0% 4.0% Market Cap $ Weight Risk Weight 6.0% 5.0% 4.0% Low Vol $ Weight Risk Weight 3.0% 3.0% 2.0% 2.0% 1.0% 1.0% 0.0% 0.0% -1.0% High concentration in large cap stocks, with unpredictable risk concentrations Overweights low risk stocks, but has erratic total risk weights, potentially high risk concentrations 6.0% 5.0% Equal Weight 6.0% 5.0% Equal Risk Weight 4.0% 3.0% $ Weight Risk Weight 4.0% 3.0% $ Weight Risk Weight 2.0% 2.0% 1.0% 1.0% 0.0% 0.0% Eliminates concentration, but overweights risky stocks Overweights low risk stocks, eliminates risk concentrations ¹The 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

8 Implementation Strategies VelocityShares Equal Risk Weight Large Cap Index ( ERW Index )

9 ERW Index Summary The ERW 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

10 ERW Index Construction Process Includes S&P 500 stocks with at least 8 months of data, then runs two optimizations: 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 10% for any constituent

11 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

12 Implementation Strategies Appendix

13 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 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

14 IMPORTANT DISCLOSURES 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. CN: VEL /31/