Low-Volatility ETF Doubles S&P 500 Risk-Adjusted Return

PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) is billed as a lower-risk equity ETF that offers downside protection, but the fund has actually outperformed the market as it nears its two-year anniversary.

“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,” says Morningstar analyst Samuel Lee in a profile of SPLV.

The ETF has sector tilts to defensive industries such as utilities at nearly 31% of the portfolio and consumer staples at about 24%. [Low-Volatility ETFs Still Hot Despite Collapsing VIX]

Since its May 2011 launch, the low-volatility ETF has gained 30% versus a 21% advance for the S&P 500 over the same period, Bloomberg News reports.

Even more impressively, the $4.1 billion ETF has doubled the risk-adjusted return of the S&P 500 when volatility is factored in. Volatility is the measurement of the tendency of a security to fluctuate in price. So SPLV has outperformed with less bumps along the way.

“The long-term outperformance of low-risk portfolios is perhaps the greatest anomaly in finance,” Harvard Business School Professor Malcolm Baker wrote in a 2011 paper in Financial Analysts Journal, Bloomberg notes.

Morningstar’s Lee says one reason the strategy outperforms is that high-volatility stocks are systematically overpriced by investors seeking “lottery tickets,” or stocks with a small chance of huge upside.

“The evidence behind low-volatility investing is truly impressive. However, low-volatility strategies can underperform during bull markets,” the analyst said.