Up 22.57% year-to-date, the iShares Edge MSCI Min Vol USA ETF (USMV) is crushing broader benchmarks and is proving to be an investor favorite. USMV has hauled in $10 billion in new assets this year, a total surpassed by just one other US-listed ETF.
USMV seeks to track the investment results of an index composed of U.S. equities that, in the aggregate, have lower volatility characteristics relative to the broader U.S. equity market. The fund offers would-be investors exposure to U.S. stocks with potentially less risk. Historically, USMV has declined less than the market during market downturns, and investors can consider USMV for a core position in a portfolio.
While defensive stocks, including some held by USMV, are looking pricey, the current environment remains conducive to more conservative postures.
“By most measures, defensive stocks, like those that USMV favors, are trading at high valuations relative to their historical range,” said Morningstar in a recent note. “Based on Morningstar’s fair value estimates for the stocks that make up USMV’s current portfolio, the fund was trading at 1.10 times the fair value at the end of August 2019. However, that does not suggest that there’s an impending correction or that this fund is a particularly risky investment.”
USMV select stocks based on variances and correlations, along with other risk factors. The low or minimum volatility strategy targets stocks that have lower expected risk or less idiosyncratic risks. Specifically, the strategy targets equities that exhibit lower beta, a measure of volatility or systematic risk of security to that of the overall market. Consequently, minimum volatility portfolios are constructed with stocks that exhibit lower market risk or beta.
“USMV’s allocation to technology stocks was higher at the end of August 2019 than it was at the end of August 2014, while its allocation to energy stocks was smaller,” said Morningstar. “These types of changes to the composition of the portfolio can explain part of the differences in valuations over time, diluting the link between current valuations and the portfolio’s future returns.”
The low-volatility factor investments work on the idea that they help cushion against market turns, limiting drawdowns that investors experience while providing upside potential. Consequently, the low- or min-vol strategies may produce better risk-adjusted returns over the long haul, which has been backed by extensive academic research.
“Historically, low-volatility stocks have done even better than that, offering comparable and at times better returns than the market, with lower volatility and downside risk,” according to Morningstar. “They’re unlikely to offer such a sweetheart deal in the future, given their current valuations, but well-constructed defensive equity strategies like USMV should continue to offer better downside protection and a better risk/reward trade-off than the market over the long term.”
For more information on factor-based investments, visit our Smart Beta Channel.