ETF Learning Centre - Beyond Beta - RBC Global Asset Management

Beyond Beta

Overcoming the pitfalls of traditional weighting strategies

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ETFs were initially introduced as an efficient, cost-effective solution designed to deliver beta-like returns – meaning similar risk levels and performance to the market.

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However, as the ETF market has developed, many of today’s ETFs aim to provide either ‘better’ or ‘enhanced’ beta (such as market-like returns with lower volatility) or alpha generation (producing returns above beta).

A simple first step towards the goal of delivering alpha or enhanced beta often involves implementing a weighting system that differs from the traditional market-cap strategy.

Let’s take a look at traditional market-cap strategies and some alternatives.

An innovative approach to weighting – the modified cap

With market-cap and equal-weight strategies, investors are forced to make a mutually exclusive decision to either accept large-cap and momentum biases or introduce small-cap biases and liquidity risk. Neither of these scenarios is desirable on a long-term basis. To address this problem, the RBC Quantitative Investment Management team designed a rules-based strategy – called modified-cap weighting – that minimizes biases and liquidity risks while providing the potential for long-term outperformance.

The modified cap in action

Take this example comparing market cap, modified and equal weighting strategies. The RBC Quantitative Investment Management team’s model lies in the middle, bridging the gap between its market-cap and equal-weight counterparts.

The strategy addresses the fact that:

  1. Most large- and mega-caps are unlikely to outperform the market in a meaningful way over the long term.
  2. Large- and mega-cap stocks do have an important diversification role to play in a portfolio.
  3. Small and mid caps are likely to outperform the broad market over the long term.

And aims to:

  1. Introduce a meaningful position in small and mid caps without problematic liquidity risk.
  2. Ensure that the weighting strategy could be implemented in a larger mandate.

The modified-cap weighting significantly reduces single-name exposure to large-cap stocks and increases exposure to smaller companies on the index.

Over the long term, this strategy should contribute to alpha more effectively relative to a cap-weighted strategy.

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Source: RBC Global Asset Management

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For illustrative purposes only.

RBC Quant Dividend Leaders ETFs and RBC Quant Equity Leaders ETFs bring the modified-cap weighting strategy, and all of its benefits, to life. Talk to your advisor about how you can enhance risk-return potential with RBC ETFs.

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