The long-term outperformance of low-volatility stocks flies in the face of modern portfolio theory; nonetheless this market “glitch” has been well-documented by academic studies. Yet the 2008 financial crisis and its lasting psychological impact on investors probably have more to do with the soaring popularity of low-volatility ETFs than any research being churned out by the Ivory Tower.
“The market crash of 2007-09 scared scores of investors out of the stock market. Many are still out, and a lot of those tiptoeing back in are wary of volatility,” writes the former executive director of Dow Jones Indexes, John Prestbo, for MarketWatch. “So, ETFs promising less fluctuation now have an eager clientele that previously didn’t exist, or was much smaller.”
However, he argues that low-volatility funds shouldn’t be considered stand-ins for diversified, total-market ETFs because they hold fewer stocks and take different sector bets.
For example, PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) has 24.4% in consumer discretionary and 30.9% in utilities, two traditionally defensive sectors. The general outperformance of defensive sectors over cyclical sectors so far in 2013 has provided a tailwind for the fund.
“This rally has been largely defensive-led,” said Mark Newton, chief technical analyst at Greywolf Execution, in a recent WSJ.com MarketBeat report.
SPLV is the largest and oldest low-volatility ETF with about $4.3 billion in assets under management.
A rival, iShares MSCI USA Minimum Volatility (NYSEArca: USMV), is actually the best-selling ETF in the category so far this year, raking in about $1.4 billion. USMV takes a slightly different approach from SPLV in that the tracking index tries to stay more diversified from a sector perspective. [Comparing the Two Largest Low-Volatility ETFs]