Low-volatility ETFs have become a popular choice with nervous investors who want stock market exposure with fewer ups and downs. However, these conservative funds may lag in a prolonged rally.
“In a sustained bull market — if you want to be invested in stocks at all — you would be much better off in a broad-based, all-in index fund than a low-volatility ETF,” wrote John Wasik at Reuters in a report this week.
“To be sure, as risk-reduction vehicles, low-volatility ETFs play it safer by investing in mature companies with steady cash flows and solid dividends. They are less likely to be sold off in a market rout such as the one experienced last year,” he added. [Low-Volatility ETFs: Wait For Full Market Cycle?]
ETF providers have rolled out several funds in the past year that are designed to provide a smoother ride for equity investors. [Ups and Downs of Low-Volatility ETFs]
The largest such fund is the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), with nearly $1.7 billion in assets. It was launched in May 2011. [What You Need to Know About Low-Volatility ETFs]
The tracking index consists of the 100 stocks in the S&P 500 with the lowest realized volatility over the past 12 months. [Sizing Up a Low-Volatility ETF]
SPLV is up 3% year to date, compared with a 10.6% return for the S&P 500. [Chart of the Day: Low Volatility ETF]
Morningstar analyst Samuel Lee says the ETF “has a lot going for it,” including very low fees and the fact that over the past 50 years, the least-volatile stocks have performed about as well as the market, but with far less risk. [ETF Spotlight: Low-Volatility Funds]
“However, low-volatility strategies can underperform during bull markets,” he added.
SPLV overweights to defensive sectors such as consumer stocks and utilities.
“This strategy may have softened the swells from the stormy markets of last year, but it’s coming up a laggard this year as a recovering economy is propelling the general market,” writes Wasik at Reuters.
PowerShares S&P 500 Low Volatility Portfolio