Research Affiliates ETF holds deleted stocks up to five years

The Research Affiliates Deletions ETF (NIXT) holds stocks cut from top 500 and top 1,000 market-cap-weighted indices for up to five years, rebalancing to equal weight once a year.

The fund tracks the Research Affiliates Deletions Index and buys companies exiled from large- and mid-cap benchmarks where pessimism has pushed valuations to extreme discounts, according to ETF Trends. Deletions from the two index families are its only source of holdings.

For an advisor running a cap-weighted core, NIXT is a satellite whose holdings are chosen by other indices' deletion rules. Ari Polychronopoulos, head of RAFI Indices, said on a TMX VettaFi webcast that the Magnificent Seven made up nearly 35% of the S&P 500, with a combined market cap above $20 trillion, and that conventional passive strategies offer little buffer if mean reversion hits those leaders, according to ETF Trends.

Cap-weighted indices add companies after their valuations have soared and drop them after extended price declines, a mechanism ETF Trends describes as forcing index investors to sell deletions and temporarily depressing those prices. The fund's premise is that the discount is artificial and reverses.

RAFI research covering 2004 to 2018 found the deleted companies beat the market by more than 5% a year over the following five years, ETF Trends reported.

Between annual resets, a holding's weight moves with its price, so a name can grow or shrink before the next rebalance. The five-year cap also sets an exit date: a stock leaves on schedule, and the index rules make no allowance for whether its rebound has run its course by then. What the fund owns in any year depends on how many companies the two benchmark families delete.