Get Defensive with Low Volatility ETFs

April 13th at 8:00am by Tom Lydon

In an attempt to mitigate market swings, investors can take a look at exchange traded funds that focus on low-volatility stocks, but don’t expect these to strategies to outperform the broader markets during bull runs.

The two largest low-volatility ETFs, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV), provide access to more conservative stock plays that tend to do better during market downturns. [Low Vol ETFs Look to Come Back Into Style]

Although both ETFs are true to their low volatility missions, there are key differences between the two funds. Specifically, USMV factors in how stocks interact with one another, weights each sector within 5 percentage points of the parent index and leans toward stocks that generate relatively stable earnings and are less sensitive to the business cycle than the broader market. SPVL, on the other hand, picks out the 100 least volatile stocks from the S&P 500. [Learning to Love Low Vol ETFs…Again]

“Low-volatility stocks historically have offered higher risk-adjusted returns than their more volatile counterparts, suggesting that the market has not offered adequate compensation for incremental risk,” writes Morningstar analyst Michael Rawson.

However, because of their conservative nature, these low-volatility ETFs will underperform high-flying beta stocks during a strong market rally. Additionally, stocks that show lower volatility have a value tilt.

“Historically, stocks with low volatility have traded at a discount to stocks with high volatility,” Rawson added. “This makes sense because more-expensive and higher-growth stocks, such as technology or consumer discretionary stocks, tend to be more volatile than cheap, but slow-growth utilities or consumer staples.”

Investors who want to take a defensive tilt toward overseas exposure can also consider international low-volatility ETFs. The iShares MSCI EAFE Minimum Volatility ETF (NYSEArca: EFAV) and the PowerShares S&P International Developed Low Volatility Portfolio (NYSEArca: IDLV) both offer exposure to developed foreign markets. Additionally, the iShares MSCI Emerging Markets Minimum Volatility ETF (NYSEArca: EEMV) and PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSEArca: EELV) provide exposure to low-volatility areas from the emerging markets. [Low-Volatility EM ETF Plays As Uncertainty Lingers]

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.