Investors are still battle-scarred from suffering through two brutal market pullbacks since 2000. They can’t seem to shake off the dot-com bust and subprime meltdown despite SDPR Dow Jones Industrial Average ETF (NYSEArca: DIA) breaking out to record highs.
That’s a big reason why low-volatility ETFs continue to sell at a rapid pace despite the CBOE Volatility Index, or VIX, dropping to its lowest level since 2007. [VIX Falls Below 12 for First Time Since Credit Crisis]
Low-volatility ETFs provide investors the ability to track broad markets with some downside protection. The low-volatility strategy has a number of academic studies to support the rationale behind the investment idea, according to VIX and More, but it is better illustrated with a side-by-side comparison.
For instance, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), which tracks 100 of the least volatile stocks of the S&P 500, has increased 18.1% over the past year while the S&P 500 index gained 16.2%. [Utilities, Low-Volatility ETFs Bought for Yield, Safety]
“Why have low-volatility stocks posted such great risk-adjusted returns? The best explanation is leverage aversion,” explains Morningstar analyst Samuel Lee. “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. Ironically, their collective bet on high-beta stocks leads to low risk-adjusted returns.”
Other ETF sponsors have also entered into the space, such as BlackRock with the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV).
Moreover, the industry has also launched a range of international low-volatility products, such as the iShares MSCI EAFE Minimum Volatility ETF (NYSEArca: EFAV), iShares All Country World Minimum Volatility ETF (NYSEArca: ACWV) and PowerShares S&P International Developed Low Volatility (NYSEArca: IDLV). In addition, there are some that focus on the emerging markets, like the iShares MSCI Emerging Markets Minimum Volatility (NYSEArca: EEMV) and PowerShares S&P Emerging Markets Low Volatility (NYSEArca: EELV).
Earlier this month, PowerShares further segmented the U.S. market, launching the PowerShares S&P Mid Cap Low Volatility Portfolio (NYSEArca: XMLV) and the PowerShares S&P Small Cap Low Volatility Portfolio (NYSEArca: XSLV). [Low-Volatility ETFs: Small and Mid-Cap Funds on Tap]
Nevertheless, low-volatility ETFs could underperform larger indices in short-term market rallies because they do not include the riskier, and potentially more profitable, stock picks. For instance, SPLV gained 8.7% over the past three months while the S&P 500 rose 10.0%.
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.