FTSE, a leading global index provider, has unveiled a suite of indices designed to track the performance of baskets of securities weighted so that each security contributes equally to overall portfolio risk.
The newly launched FTSE Global Equal Risk Contribution (ERC) Index Series aims to achieve maximum risk diversification and avoid concentration in stock-specific risk.
Called the FTSE Global Equal Risk Contribution (ERC) Index Series, the new index series fits within FTSE’s range of alternative indices, which break the relationship between market capitalisation and index weight.
Kevin Bourne, Managing Director, FTSE Group, said: “We are delighted to announce the launch of the FTSE Equal Risk Contribution Index Series, which further expands FTSE’s industry-leading range of alternatively weighted indices and provides new benchmarking solutions.”
Alternatively weighted indices – often dubbed ‘smart beta’ – are typically designed to achieve a certain portfolio objective, such as reducing concentration in individual sectors or securities, lowering volatility, diversifying beta, tilting towards or away from certain factors, improving risk/reward trade-offs or timing market events.
The objective of the new FTSE series is to achieve maximum risk diversification within their defined security universe, thereby avoiding concentration of specific risk. According to Bourne: “The FTSE ERC series seeks to reduce concentration risk, with all stocks contributing equally to index risk or volatility, and represents the most diversified index in terms of risk contribution.”
The approach, a form of risk-parity strategy where securities with lower estimated volatility and correlation receive larger weights than those with higher estimated volatility and correlation, blends together concepts borrowed from both equal weight and minimum volatility strategies. Importantly for investors, the approach has tended to deliver both reduced portfolio concentration and lower volatility whilst maintaining full exposure to the underlying security universe and delivering comparable levels of absolute performance.
Statistics released by FTSE support this observation. A comparison of the FTSE All-World Equal Risk Contribution Index with the market-capitalisation weighted FTSE All-World Index, its underlying universe, reveals that the ERC version has achieved broadly similar returns to the market-cap version, but has achieved these returns whilst exhibiting materially lower volatility and smaller drawdowns.
FTSE is not the first of the major index providers to implement an equal risk approach. That record appears to belong to Stoxx who, back in June 2012, launched the Euro iStoxx 50 Equal Risk Index. This index applies an equal risk approach to the widely followed Euro Stoxx 50 Index of eurozone blue-chips and has subsequently been adopted as the underlying index to the NYSE Euronext-listed Lyxor ETF Smartix Euro iStoxx 50 Equal Risk (ERC).
More recently, VelocityShares, a US-based provider of exchange-traded products, has made a play in this space with the launch of the VelocityShares Equal Risk Weighted Large Cap ETF (ERW) on the NYSE Arca in August. This fund is linked to the VelocityShares Equal Risk Weighted Large Cap Index, a proprietary index which applies an equal risk contribution concept to the constituents of the S&P 500 Index.
Although not the first indices in this space, the new FTSE series is by far the most comprehensive offering to date, encompassing 14 indices covering a range of regions, sub-regions and individual countries (see below).
In common with all FTSE indices, the series is managed according to a publicly available set of rules and overseen by an independent committee of seasoned market practitioners. The indices are fully investable and have been designed for use both as performance benchmarks for actively managed funds or as underlying reference indices for index-linked investment products such as ETFs.
The indices are calculated on an end-of-day basis and are available in price, total return and net-of-tax formats and in USD, EUR, GBP, JPY, AUD and local currency.
The full series is as follows:
FTSE All-World Equal Risk Contribution Index
FTSE Developed Equal Risk Contribution Index
FTSE Developed ex Japan Equal Risk Contribution Index
FTSE Developed ex Korea ex Israel Equal Risk Contribution Index
FTSE Developed Asia Pacific Equal Risk Contribution Index
FTSE Developed Asia Pacific ex Japan Equal Risk Contribution Index
FTSE Developed Asia Pacific ex Korea Equal Risk Contribution Index
FTSE Developed Europe Equal Risk Contribution Index
FTSE Developed Europe ex UK Equal Risk Contribution Index
FTSE Eurobloc Equal Risk Contribution Index
FTSE North America Equal Risk Contribution Index
FTSE Emerging Equal Risk Contribution Index
FTSE Japan Equal Risk Contribution Index
FTSE USA Equal Risk Contribution Index