With many lingering global market risks and now a potential Federal Reserve interest rate hike ahead, exchange traded fund investors may look to a low-volatility strategy that specifically excludes rate-sensitive stocks.
The PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (NYSEArca: XRLV) gives investors the ability to combine the low volatility and hedging rising rates themes. The underling index is composed of the 100 constituents of S&P 500 Index that exhibit both low volatility and low interest-rate risk.
Related: ETFs to Smooth Out a Volatile Ride
The low-volatility theme has been a popular strategy this year as investors turned to conservative bets in the wake of wild market swings. The low-vol strategy targets stocks that have lower expected risk or less idiosyncratic risks. Specifically, the strategy focuses on equities that exhibit lower beta, a measure of volatility or systematic risk of a security to that of the overall market. Consequently, minimum volatility portfolios are comprised of stocks that exhibit lower market risk or beta.
Related: Slow-and-Steady ETFs for a Volatile Market
“With Capital IQ consensus expectations for just 0.1% of earnings growth in 2016, combined with the uncertainty about the upcoming Presidential election and increased possibility of a June Fed Funds rate hike, stock market volatility should remain in the near term,” according to S&P Global Market Intelligence Equity Strategist Sam Stovall.
However, if we see a Fed rate hike in June or July, high-dividend stocks, like utilities or some household product companies, could mirror other rising rate periods and be negatively impacted, Todd Rosenbluth, S&P Global Market Intelligence Director of ETF Research, said in a research note.
[related_stories]Consequently, ETF investors may look to the targeted XRLV, which overweights industrials 25.1% and health care 18.8%. Moreover, the low-vol, ex-rate sensitive ETF excludes utilities, only includes a 1.3% tilt toward yield-generating telecoms and holds a smaller 14.7% tilt toward consumer staples. In contrast, the more popular PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) includes a heavy 21.6% position in consumer staples and 21.1% in utilities.
However, potential investors should keep in mind that XRLV is still rather thinly traded, showing a 24,500 average daily volume, according to Morningstar data. Consequently, traders should implement limit orders to better control trades and Advisors executing large orders can also turn to alternative liquidity providers.
“More often than not, smaller ETFs offer very limited volume and stated bid/ask spreads wider than those of the larger ETFs,” Chris Hempstead, Head of ETF Sales for KCG, told S&P Capital IQ. “Investors with interest in ETFs with lower volume and wider spreads could benefit by simply making a call to the capital markets team of the issuer or by calling an ETF trading desk to determine true liquidity.”
For more information on smart-beta strategies, visit our smart-beta category.
PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio