Index Exile Opportunities: The Research Affiliates Deletions ETF

Market-capitalization-weighted indices typically operate on a mechanical cycle. Companies enter an index after soaring valuations capture investor euphoria, while exiting firms are cast out following extended price declines due to operational disappointment and/or negative sentiment. This price-driven mechanism often forces passive strategies to buy near cyclical peaks and sell near market bottoms. This creates missed opportunities in the market, especially when it comes to companies that are deleted from an index. Conversely, the Research Affiliates Deletions ETF (NIXT ) takes advantage of this missed opportunity by targeting long-term price reversals in companies dropped from traditional market-cap indices.Key Takeaways: Market-capitalization-weighted indices systematically force passive strategies to buy high and sell low by mechanically purging companies after extended price declines. NIXT purchases stocks removed from the top 500 and 1,000 U.S. benchmarks. It holds them for a maximum of five years with annual equal weighting to capture long-term mean reversion. Based on RAFI™ research from 1991 to 2018, discarded companies historically outperform broad market indices by over 5% annually following removal. This makes NIXT an effective small-cap value complement to portfolios. See More: Nixed: The Upside of Getting DumpedA Contrarian Approach to Index RemovalsTracking the Research Affiliates Deletions Index, NIXT purchases stocks exiled from large- and mid-cap benchmarks. It seeks to capture opportunities where market pessimism has driven valuations to extreme discounts. More specifically, the fund purchases deletions from top 500 and top 1,000 market-cap-weighted indices. It holds them for a maximum of five years and rebalances them annually to equal weight. RAFI research demonstrates that these deleted companies frequently outperform the benchmarks that cast them aside in the years following removal. Companies dumped from major market-cap-weighted indices suffer from severe, artificial selling pressure (from index investors selling their shares) that temporarily depresses their valuations. However, rather than experience a permanent downward spiral, these deletions historically stage significant long-term rebounds. The research data, which spans from 2004 to 2018, revealed that these companies outperformed the market by more than 5% per year over the subsequent five-year period through long-term mean reversion.Why NIXT Suits Today's MarketIn an equity environment defined by historic concentration in megacap technology and elevated valuation dispersion, core portfolios face substantial momentum risk. This was a topic of discussion in a recent TMX VettaFi webcast where Ari Polychronopoulos, head of RAFI Indices, noted that the Magnificent Seven has grown to represent nearly 35% of the S&P 500 with a combined market cap of over $20 trillion. If mean reversion occurs among market darlings, conventional passive strategies offer little buffer against top-heavy drawdowns. As such, investors have been gravitating to small-cap opportunities, particularly in the first half of the year. NIXT provides a distinctive complement to core equity exposures by offering targeted small-cap value exposure through recent index deletions. This occurs because discarded companies typically migrate into the small-cap value segment. As such, NIXT delivers a disciplined entry point into deeply discounted securities poised for mean reversion. By systematically capturing the upside of unloved companies rather than chasing past winners, NIXT allows investors to harness the hidden value of benchmark turnover. The fund essentially turns index exiles into a strategic driver of long-term outperformance. For more information on the NIXT ETF, click here. Click here to learn more about the Research Affiliates Deletions Index that NIXT uses. For more news, information, and strategy, visit the Smart Beta Content Hub. VettaFi LLC (“VettaFi”) is the index provider for NIXT, for which it receives an index licensing fee. However, NIXT is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of NIXT.