With U.S. stocks flailing and the S&P 500 officially in correction territory, investors looking to remain long equities or establish new bullish positions ought to consider the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV).
The two are home to a combined $10.5 billion in assets under management. Each ETF features surprisingly small utilities sector allocations as well as some significant sector-level differences. That does not mean utilities are suddenly see a surge in volatility. Despite rising Treasury yields, utilities sector volatility is only slightly above long-term averages. Rather, declining volatility for the financial services sector in the years since the financial crisis has allowed the S&P 500 Low Volatility Index, SPLV’s underlying benchmark, to increase exposure to that sector. [Why This ETF’s Utilities Weight is so Small]
Consequently, investors should dive deeper into the ETFs to get a better handle of what they are investing into. For instance, SPLV does not include energy stocks, which have the worst performers in the S&P 500 this year.
SPLV shows a 3-year trailing standard deviation of 8.79 and a Sharpe Ratio of 1.67, while the S&P 500 has a 9.59 standard deviation and 1.61 Sharpe Ratio, according to Morningstar data. Additionally, USMV shows a 8.24 standard deviation and a 1.83 Sharpe Ratio. Standard deviation is a measure of dispersion from its mean, so a greater deviation reflects greater volatility. Additionally, the Sharpe Ratio is a measure of calculating the risk-adjusted return and a greater value typically reflects a more attractive risk-adjusted return. [Surprises in Low Volatility ETFs]
“Investors need to keep in mind, though, that low volatility can also bring returns that trail the market. In 2011, when the S&P 500 was on fire, returning 32 percent, SPLV had a return of 23 percent. This is SPLV working as advertised—a muted reaction on the way down in return for lagging on the way up,” reports Eric Balchunas for Bloomberg.
The differing methodologies and potential for some lag when riskier fare leads equities higher has not deterred investors from low volatility ETFs. Low volatility ETFs are among the most popular smart beta strategies and have over $15 billion in combined assets.
PowerShares S&P 500 Low Volatility Portfolio
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.