For example, SPLV’s construction is “admirably simple and transparent,” says Morningstar analyst Samuel Lee.
The index consists of the 100 stocks from the S&P 500 with the lowest realized volatility over the past 12 months. [Low-Volatility ETF Doubles S&P 500 Risk-Adjusted Return]
“The index weights stocks by the inverse of their volatilities, so steadier stocks take a bigger share of assets,” Lee writes in a report on the ETF. “In practice, the fund is close to equal-weighted because stocks’ individual volatilities tend to be less divergent than their market capitalizations. Naturally, with a low-volatility bent, the fund emphasizes defensive sectors such as utilities and consumer staples.”
SPLV has 30.7% in utilities and 24.4% in consumer staples, according to manager Invesco PowerShares. The ETF charges an expense ratio of 0.25%. The fund has posted a total return of 11.9% year to date, compared with 10.2% for the S&P 500.
USMV, the iShares ETF, has a more complex approach. The MSCI USA Minimum Volatility Index tries to build the least-volatile portfolio of U.S. stocks, but with certain restrictions.
“The constraints revolve around trying to keep the index diversified on both stock and sector levels, while capping turnover,” says Lee at Morningstar. The constraints include keeping stock weights within 0.05% to 1.5% of the portfolio, sector weightings within 5% of the market-weighted index, and a one-way turnover of 10%.
“The model may help reduce inadvertent tilts beyond simple low volatility equity exposure but introduces some uncertainty as to how the strategy will behave in the future,” Lee adds. “Despite this, we’re confident the portfolio will be less volatile than its market-weighted parent index.”
USMV is more diversified in terms of spreading the portfolio more evenly across sectors. For example, no one sector accounts for more than 18% of the fund.
USMV holds 126 stocks and levies an expense ratio of 0.15%. The ETF has gained 12.3% so far this year.