Market volatility in the wake of the financial crisis has damaged the psyche of average investor. Consequently, the exchange traded fund industry has seen heavy interest in low-volatility investment strategies that try to smooth out the swings.
Low-volatility ETFs have seen strong inflows and could attract more attention as the market hits an air pocket this week.
The iShares MSCI U.S. Minimum Volatility ETF (NYSEArca: USMV) has been the most popular low-volatility option so far this year, attracting $2.22 billion in new inflows year-to-date, according to IndexUniverse. The PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), the largest and oldest low-volatility ETF, has garnered $1.15 billion in assets this year. [Low-Volatility ETFs Enjoy Their Time in the Sun]
Burned by the 2008 downturn and subsequent rocky few years, skittish investors have turned to low-volatility options for some downside protection. These funds provide a safer bet on the markets, but the investments could lag behind in short-term bullish markets due to their exposure to their more conservative nature.
Nevertheless, low-volatility stocks have outperformed the market, both domestically and abroad, over longer periods, with better risk-adjusted returns, according to many academic studies.
“Low-volatility stocks tend to be big, boring, and dividend-paying,” Morningstar analyst Samuel Lee writes. “Interestingly, in nearly every market studied, low-volatility stocks have outperformed high-volatility stocks, a finding at odds with many investors’ notions of risk and return.”
As the popularity of low-volatility strategies grows, the ETF industry has come out with many various options, such as the “low”-volatility SPLV and the “minimum”-volatility USMV. Despite their differing appellations, the two funds have a “very similar strategy,” according to Lee. [Comparing the Two Largest Low-Volatility ETFs]
“USMV attempts to create the least volatile portfolio possible with U.S. large- and mid-cap stocks, the so-called minimum variance portfolio, while neutralizing style-, sector-, and stock-level deviations from the market-cap-weighted portfolio,” Lee explained.
Additionally, USMV comes with certain restrictions, including stock weights withing 0.05% and 1.5% of the portfolio, sector weightings within 5% of the market-weighted index and a one-way turnover of 10%, Lee added.
SPLV tracks 100 stocks from the S&P 500 that have shown the least volatility over the past year, and the index weights holdings by the inverse of their volatilizes, so more stable stocks have a heavier weighing.
Looking at sector allocations, USMV seems to spread out its sector exposure, with health care at 17.9%, consumer staples at 15.9% and financials 14.9%, while SPLV has a heavier weighting in utilities 31.1% and consumer staples 24.2%.
In comparing fees, USMV comes with a 0.15% expense ratio and SPLV has a 0.25% expense ratio.
The iShares ETF is up 14.8% year-to-date and the PowerShares fund is up 15.5% so far this year.
For more information on low-volatility funds, visit our low-volatility category.
Max Chen contributed to this article.