Three Types of Low-Volatility ETFs
December 28th, 2012 at 6:10am by Tom Lydon
The string of financial crises in recent years has been etched on the market’s psyche. As a way to mitigate oscillations in their portfolios, investors are turning to a number of low-volatility exchange traded fund options to hedge against potential risks down the road.
Low-volatility strategies tend to underperform during a bull market, but during times of market uncertainty, these types of investments can provide decent risk-adjusted returns.
One of the most popular option has been the PowerShares S&P 500 Low Volatility ETF (NYSEArca: SPLV), which garnered almost $3.1 billion since its launch in May 2011. SPLV holds the 100 stocks of the S&P 500 Index that has shown the lowest realized volatility over the last year. [Low-Volatility ETFs: The New Safe Haven]
Still, with the ever expanding universe of ETFs, investors have other tools on hand. For instance, the Direxion S&P 500 DRRC Volatility Response Shares (NYSEArca: VSPY) tackles the volatility issue through another methodology as a way to generate a greater risk/return portfolio.
Specifically, VSPY mitigates risk by changing its equity exposure to the S&P 500 based on a volatility index. The fund’s equity exposure is calculated by dividing the target volatility of 15% by the S&P 500′s volatility. Consequently, depending on the volatility level, VSPY can take on a cash position in T-Bills of 0% to a little over 80%.
More recently, two “tail” or “downside” hedged ETFs have been launched: the First Trust CBOE S&P 500 VIX Tail Hedge Fund (NYSEArca: VIXH) and PowerShares S&P 500 Downside Hedged Portfolio (NYSEArca: PHDG). Both funds will shift its position in the S&P 500 and call options on VIX futures, based on current market volatility. [PowerShares Readies ‘Downside Hedged’ ETF]
The tail hedging strategy protects a portfolio from extreme market oscillations due to unpredictable, random and unexpected events, or “Black Swan” events. The term was coined in a 2007 book by Nassim Nicholas Taleb published right before the financial crisis hit.
For more information on low-volatility funds, visit our low-volatility category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.