In a recent episode of Behind the Ticker, Rob Arnott, founder and chairman of Research Affiliates, shared insights into the firm's latest innovation, the Research Affiliates Deletions ETF (ticker: NIXT). With nearly 50 years in investment management, Arnott has built a reputation for pioneering quantitative investing strategies, particularly through the development of the Fundamental Index methodology. Research Affiliates, founded in 2002, now indirectly oversees $158 billion in assets through partnerships with firms like Schwab, Invesco, and PIMCO.

Arnott explained that NIXT was created to exploit inefficiencies in traditional market-cap-weighted indexes. When companies are removed from major indices like the S&P 500 or Russell 1000, they often experience exaggerated price declines, pushing them to deep value levels. Historically, these "deleted" stocks tend to recover significantly, often outperforming the market in the years following their removal. NIXT systematically captures this mean reversion by identifying and investing in stocks that have been dropped from indices due to temporary underperformance rather than fundamental deterioration.

The fund follows a rules-based process where deletions from the top 500 and top 1,000 market cap rankings are screened for quality metrics, eliminating the bottom 20% to avoid value traps. The remaining stocks are then held in equal weight for five years, allowing time for revaluation and recovery. Arnott noted that this approach benefits from both the structural inefficiencies of index deletions and the broader opportunity in small-cap and deep value stocks, which are currently trading at historically low relative valuations.

Arnott positioned NIXT as a unique completion strategy, complementing traditional market-cap-weighted portfolios by reintroducing stocks that indices have discarded too soon. While not intended as a core allocation, NIXT provides an alternative way for investors to gain small-cap value exposure with a systematic, contrarian approach.

Rob Arnott - Research Affiliates