Portfolio Diversity Made Easier With This ETF

Many index funds and exchange traded funds claim to offer investors adequate portfolio diversification. In some cases, the diversification offered by those products can be called into question.

The Nationwide Maximum Diversification U.S. Core Equity ETF MXDU, which launched in September 2017, offers a different, potentially more effective approach to equity diversification.

What Happened

MXDU targets the TOBAM Maximum Diversification USA Index, which “is a systematic, rules-based index that provides exposure to mid and large cap U.S. listed companies. The index seeks to maximize a patented mathematical measure of portfolio diversification, based on constituent volatilities and cross correlations,” according to Nationwide.

Home to nearly 500 stocks, MXDU aims for neutral risk allocation with a stock selection process that's bolstered by various socially responsible investing (SRI) criteria. The fund employs a metric known as the Diversification Ratio.

“This is based on the idea that diversification should reduce the portfolio’s risk rela­tive to the risk of its holdings,” said Morningstar in a note out last week. “The diversification ratio is larger for portfolios that hold assets with lower correlations to each other because uncorrelated risk largely offsets at the portfolio level.”

Why It's Important

Some of MXDU's diversification is seen at the individual holding level as none of the fund's 481 holdings exceed weights of 1.55 percent. In the S&P 500, the top seven stocks all command weights larger than 1.55 percent. The S&P 500 allocates 20.77 percent of its weight to the technology sector, or more than 800 basis points above MXDU's weight to that group.

MXDU's approach can create a defensive, lower volatility portfolio.

“The fund tends to tilt toward stocks with a high ratio of firm-specific (idiosyncratic) to nondiversifiable (systemic) risk because they typically have low correlations with one another,” said Morningstar. “These stocks tend to have lower-than-average sensitivity to market risk (market betas of less than 1.0), though the fund still includes some names with high market risk.”

Highlighting its defensive tilt, MXDU allocates nearly a third of its weight to health care and consumer staples stocks, but even while playing defense, the fund's largest sector exposure is consumer discretionary at 20.11 percent.

What's Next

MXDU's performance can be affected by shifts in market concentration.

“TOBAM argues that this strategy should perform well relative to the market when market concentration declines and struggle when market concentration increases (among stocks or sectors),” said Morningstar. “This is because when market concentration increases, the stocks and sectors with the largest weightings in the index, which this fund underweights, have outperformed.”

MXDU charges 0.34 percent per year, or $34 on a $10,000 investment.

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