Low-Volatility ETFs

Investors are still battle-scarred from suffering through two brutal market pullbacks since 2000. They can’t seem to shake off the dot-com bust and subprime meltdown despite SDPR Dow Jones Industrial Average ETF (NYSEArca: DIA) breaking out to record highs.

That’s a big reason why low-volatility ETFs continue to sell at a rapid pace despite the CBOE Volatility Index, or VIX, dropping to its lowest level since 2007. [VIX Falls Below 12 for First Time Since Credit Crisis]

Low-volatility ETFs provide investors the ability to track broad markets with some downside protection. The low-volatility strategy has a number of academic studies to support the rationale behind the investment idea, according to VIX and More, but it is better illustrated with a side-by-side comparison.

For instance, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), which tracks 100 of the least volatile stocks of the S&P 500, has increased 18.1% over the past year while the S&P 500 index gained 16.2%. [Utilities, Low-Volatility ETFs Bought for Yield, Safety]

“Why have low-volatility stocks posted such great risk-adjusted returns? The best explanation is leverage aversion,” explains Morningstar analyst Samuel Lee. “Investors who target above-market returns may be unwilling or unable to use leverage to reach their expected-return targets. By resorting to volatile stocks (more accurately, high-beta stocks), which theoretically should outperform less-volatile stocks, they hope to earn above-average profits. Ironically, their collective bet on high-beta stocks leads to low risk-adjusted returns.”

Other ETF sponsors have also entered into the space, such as BlackRock with the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV).