CDC - CDC: A Solid Market Timing ETF

2023-11-23 00:59:56 ET

Summary

• VictoryShares US EQ Income Enhanced Volatility Wtd ETF seeks to track the performance of the Nasdaq Victory US Large Cap High Dividend 100 Long/Cash Volatility Weighted Index.
• CDC uses a complex investment approach to reduce risk, focusing on dividend-paying stocks and market timing to adjust equity exposure.
• The Fund has achieved very strong risk-adjusted performance historically.
• CDC is currently underweight equities and thus I am initiating a hold but would consider upgrading the fund once it increases equity exposure.

ETF Overview

The VictoryShares US EQ Income Enhanced Volatility Wtd ETF ( CDC ) seeks to provide results that track the performance of the Nasdaq Victory US Large Cap High Dividend 100 Long/Cash Volatility Weighted Index ("The Index"). The Index reduces exposure to equity markets during periods of significant market decline and reinvests when market prices have further declined or rebounded.

CDC has ~$1.1 billion in net assets and currently charges a net expense ratio of 0.38%. Currently, the fund is 24% invested in equities with the remaining 76% invested in cash.

Management Fee

CDC has a moderately high expense ratio of 0.38%. To put that into context the average equity ETF expense ratio is ~0.16%. Comparably, the iShares MSCI USA Min Vol Factor ETF ( USMV ) charges a total expense ratio of 0.15% while the Invesco S&P 500 Low Volatility ETF charges a total expense ratio of 0.25%. Thus, CDC's fee of 0.38% strikes me as fairly high given these comparisons.

Index Methodology

The Index combines fundamental screening criteria with individual risk control achieved through volatility weighting of individual securities.

The Index universe begins with the stocks included in the Nasdaq Victory US Large Cap 500 Volatility Weighted Index, which is a volatility-weighted index comprised of the 500 largest U.S. companies by market capitalization with positive earnings over the last twelve months.

As a next step, the Index identifies the 100 highest dividend-yielding stocks in the Nasdaq Victory US Large Cap 500 Volatility Weighted Index. Finally, these 100 stocks are weighted based on their daily volatility over the trailing 180 trading days. Stocks with lower volatility receive a higher weighting and stocks with higher volatility receive a lower weighting.

The Index is reconstituted in March and September each year and is adjusted to limit individual sector exposure to 25%.

Furthermore, the index follows a mathematical construction process designed to limit risk during a period of significant market decline by reducing its exposure to the equity market by allocating a portion of the index to cash.

During a period of "significant market decline" that is 8% or more but less than 16% (the initial trigger point) from the Reference Index's all-time high based on the most recent month-end closing value, the Index will allocate 75% to cash and the remaining 25% to stocks in the Reference Index.

The Index will reallocate all or a portion of cash back to equities according to the following criteria:

The Index will return to being 100% allocated to stocks if the subsequent month end closing value of the stocks in the Reference Index returns to a level that is less than the initial trigger point.

If the Reference Index declines by 16% or more but less than 24% from its all-time daily high closing value as measured at a subsequent month end, the Index will reallocate an additional 25% to the stocks in the Reference Index at their current securities weightings and the Index will then be 50% allocated to stocks included in the Reference Index.

If the Reference Index declines by 24% or more but less than 32% from its all-time daily high closing value as measured at a subsequent month end, the Index will reallocate another 25% to the stocks of the Reference Index at their current securities weighting and the Index will then be 75% allocated to stocks included in the Reference Index.

If the Reference Index declines by 32% or more from its all-time daily high closing value as measured at a subsequent month end, the Index will reallocate the remaining 25% to the stocks in the Reference Index at their current securities weighting. At this point, the Index will be 100% allocated to stocks included in the Reference Index.

Thus, CDC tries to achieve lower than market volatility through both stock selection and market timing. On the stock selection side, the fund is focused on high-paying dividend stocks and then overweights those with the lowest volatility. On the market timing side, the fund is engaged in a strategy that seeks to reduce equity exposure during the early part of a market decline while increasing equity exposure during further equity market declines.

Historical Performance

CDC launched in July 2014 and has delivered a solid performance. Since its inception, CDC has delivered a total return of 115% compared to a 173% return delivered by the S&P 500, a 139% total return delivered by USMV, and an 89% return delivered by the iShares Russell 1000 Value ETF ( IWD ). However, total returns do not tell the whole story as CDC has achieved its results with significantly less volatility than the S&P 500.

On a risk-adjusted basis, CDC has performed significantly better. CDC has realized an average 30-day volatility in line with USMV and ~20% less than the S&P 500. Additionally, CDC has realized an average 3-year trailing Sharpe ratio which is slightly higher than the S&P 500 and USMV. This solid historical risk-adjusted performance suggests the fund's market timing strategy has performed reasonably well.

Additionally, CDC's performance is even more impressive when considering its bias towards value stocks. CDC tends to invest mostly in value stocks due to its focus on investing in high-yielding companies. Value stocks have not performed well compared to growth stocks since CDC's inception.

Holdings Analysis

As shown by the table below, CDC's largest holding is currently cash which accounts for nearly 76% of the fund. While CDC's near-term relative performance will be driven by its large underweight to equities and overweight to cash, it is important to consider the 26% of the fund invested in stocks as this weight is likely to increase over time once there is a signal change.

The equity portion of the portfolio is well diversified with the largest holding being Coca-Cola ( KO ) which accounts for just 0.46% of the fund.

In terms of style, CDC's equity portfolio is heavily tilted towards value. 28.9% of CDC's equity holdings are large-cap value companies while 42% are mid-cap value companies. The remaining holdings are primarily mid-cap blend companies and large-cap blend companies which account for 20.9% and 7.6% of the fund currently.

In regard to sector allocation, CDC is heavily exposed to defensive sectors such as Utilities and Consumer Staples which account for 25% and 15.6% of equity holdings, respectively. Comparably, Utilities and Consumer Staples make up just 2.4% and 6.2%, respectively, of the S&P 500.

Conclusion

CDC is a relatively innovative ETF as it is focused on a sophisticated rules-based market timing approach intended to reduce risk. While there are many products that aim to reduce downside risk while capturing market upside, CDC stands out for its strong historical risk-adjusted performance.

CDC employs a relatively complex investment approach that uses multiple levers to reduce risk. One lever is a focus on dividend-paying stocks which tend to be lower risk and lower volatility than the broad market. CDC also weights its holdings based on volatility with low volatility stocks receiving the highest weighting. In addition to a focus on high dividend and low volatility stocks, CDC also reduces risk through its market timing approach which sometimes results in equity exposure being well below 100%.

This complex approach has delivered solid results as far as the CDC has been able to deliver solid risk-adjusted results compared to the S&P 500 and other products designed to reduce risk such as USMV. CDC's performance track record is even stronger when compared to value-focused products such as the IWD, which is an appropriate benchmark given the CDC's style bias towards value stocks.

Given my relatively bullish view on equity markets, I would not buy CDC right now as the fund is heavily underweight equities and overweight cash currently. However, I am initiating the fund with a hold rating as I would consider upgrading the fund to a buy once its equity exposure increases.

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