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.
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.