New York-headquartered Indxx has launched a new US equity index that follows a mean reversion strategy.
The strategy tracks companies with recent short-term negative returns that are expected to rebound sharply.
Mean-reversion assumes that there is an underlying stable trend in the price of an asset and prices fluctuate randomly around this trend. Values deviating far from the trend will tend to reverse direction and revert to the trend.
With reference to the newly unveiled Indxx US Fallen Knives Index, the strategy tracks companies with recent short-term negative returns that are expected to rebound based on momentum and financial health indicators.
Rahul Sen Sharma, Managing Partner at Indxx, commented, “As a testament to our continued ability to create novel thematic and multi-factor indices, we’ve developed this unique index to allow for tracking of the well-known mean reversion and ‘fallen knives’ theories that have been documented in a number of financial studies over the years.”
According to Indxx, the US Fallen Knives Index may be used as the underlying reference for investment products including ETFs.
“This index, thanks to also including built-in investability and liquidity filters, is one of the first indices built that will allow it to be used for liquid financial products,” notes Sen Sharma.
Methodology
The index selects constituents from a universe of US-listed common stocks and American Depository Receipts with market capitalizations above $500 million and average daily trading volume greater than $5m.
Securities with a one-year total return excluding the most recent month below -15% are short-listed.
These securities are then assigned a composite quality score based on three metrics: current ratio, cash flow coverage ratio, and debt to equity. The top 50 securities with the highest composite scores are selected and weighted by free-float market capitalization subject to a cap of 4.9%.
The index is reconstituted annually and rebalanced semi-annually with buffer rules to limit unnecessary turnover.
The mean-reversion approach is likely to appeal to investors in the current environment following an epic market sell-off driven by the Covid-19 pandemic. By focusing on companies with quality fundamentals, the strategy aims to select firms that were oversold and have the financial resilience to withstand the current recession and make a comeback.
Several index providers have also brought out new indices recently that are linked to trends associated with Covid-19. Solactive unveiled the Solactive Remote Work Index, tracking a portfolio of companies that specialize in providing products that focus on the ability to work from home. The index is due to underlie a new ETF from US sponsor Direxion.
Meanwhile, EQM Indexes introduced a thematic suite that includes indices aligned with ‘Work from Home’, ‘Stay at Home’, ‘Covid-19 Stocks’, and ‘Global Pandemic Disruption’ investment themes.