Low-volatility exchange traded funds have earned the spotlight in these uncertain economic times. These stocks and indices are known for mitigating risk when markets are seeing big swings.
“Researchers have come up with several explanations as to why low-volatility stocks post such great risk-adjusted performances. The most convincing involves leverage aversion. Investors who target above-market returns may be unwilling or unable to use leverage to reach their expected-return targets. By resorting to volatile stocks (more accurately high-beta stocks), which theoretically should outperform less-volatile stocks, they hope to earn above-average profits,” Samuel Lee wrote in a Morningstar fund analysis. [Sizing Up a Low-Volatility ETF]
Typically, lower risk is associated with lower returns, however a study by Standard & poor reveals otherwise. Dave Fry for TheStreet reports that Standard & Poor’s backtested from 1991 to present and found that their low-volatility indices annualized returns of 9.6% actually beat the S&P 500’s 7.6%. [Chart of the Day: Low-Volatility]
There are other factors that come into consideration besides simple risk and return. Overall, money managers pay more for riskier stocks since they attract more money to their funds and perform well during bull runs. Low volatility stocks can trade at discounts during a bull market because they are often overlooked.
A drawback of low volatility funds and indices is that they can sit out on sudden gains in the market and return average amounts. The payoff is if the market takes a downturn, the investment is more protected. [What You Need to Know About Low-Volatility ETFs]
- MSCI USA Minimum Volatility Fund (NYSEArca: USMV)
- PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV)
- Russell 100 Low Volatility ETF (NYSEArca: LVOL)
Tisha Guerrero contributed to this article.