Arnott's Debut ETF Bets on Index Rejects
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Legendary investor Rob Arnott is jumping into the ETF game with a strategy of buying stocks as they are dropped from major market indexes.
Arnott, founder and chairman of Research Affiliates in Newport Beach, Calif., is the brains behind the Research Affiliates Deletions ETF (NIXT), which begins trading Sept. 10.
NIXT will track the Research Affiliates Deletions Index made up of between 140 and 180 companies that have been removed from the S&P 500 and Russell 1000 indexes over the past five years.
The index methodology, which is a relatively straight forward small-cap value play, is based on Arnott’s research showing that companies dropped from indexes because they fall below market-capitalization minimums tend to outperform the respective indexes over the next five years.
“It’s like picking up coins dropped by a rich man walking down the street,” Arnott said, citing a 7% average 12-month outperformance for dropped stocks.
That average outperformance grows to 28% when the period is extended to five years, he added.
NIXT Strategy "Quasi Active"
Arnott, whose Research Affiliates manages $150 billion through affiliated business relationships, describes the NIXT strategy as “quasi active” even though it is tracking an index.
Based on historical patterns of companies being dropped from indexes, Arnott anticipates NIXT will see an annual turnover rate of between 20% and 40%, with each stock being held for a five-year period.
To avoid crossing over into the proprietary methodologies of the S&P and Russell indexes, Arnott said the Research Affiliates Deletions Index is not designed to perfectly replicate the two brand name indexes, but that it will track similar universes of stocks.
To reduce portfolio turnover, he explained, a 10% banding is used so that a stock has to fall out of roughly the top 550 or 1100 names before it is treated as a deletion from an index.
“Our decision in sponsoring this ETF was driven by a desire to make the index deletions strategy as accessible as possible,” Arnott said.
NIXT has an expense ratio of 39 basis points but is only charging 9 basis points for the first 12 months of trading.