Investors often turn to low volatility exchange traded funds, such as the Invesco S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), when broad market volatility spikes, pressuring higher beta, growth sectors and riskier assets.
The low-volatility ETFs are factor-based strategies that tilt toward companies with a propensity for lower volatility. Different issuers and index providers arrive at a basket of low volatility stocks in varying fashions. Historical data confirm that over long holding periods, the low volatility factor is rewarding for investors.
“The S&P 500 Low Volatility Index outperformed the U.S. equity benchmark between February 1972 and November 1990, both in absolute terms and on a risk-adjusted basis,” according to S&P Dow Jones Indices. “Its higher annualized returns and lower volatility than the S&P 500 resulted in a risk/reward ratio of 0.98, which was similar to the ratio observed during the latter period. Hence, the S&P 500 Low Volatility’s returns were similarly compensated for the risks being taken in the 1970s and 1980s compared to the period since December 1990.”
SPLV tracks the S&P 500 Low Volatility Index, a collection of the 100 S&P 500 members with the lowest trailing 12-month volatility.
Impressive Track Record
Among smart beta exchange traded funds dedicated to individual investment factors, low volatility products have been popular with conservative investors based on the premise that emphasizing a low volatility strategy can help reduce a portfolio’s downside potential.
“While both indices posted similar average monthly total returns during the two distinct periods – before Dec. 1990 and since Dec. 1990 – the hit rates show that the low volatility index was slightly better (worse) at beating the S&P 500 during up (down) months before December 1990,” notes S&P Dow Jones. “Although this contributed to the low volatility index capturing a greater proportion of S&P 500 returns in the earlier period – it typically captured around 90% of the equity benchmark’s monthly gains and 65% of the S&P 500’s monthly declines – the S&P 500 Low Volatility index still offered upside participation and downside protection.”
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.
“Given these characteristics helped the low volatility index to outperform the broad-based market benchmark, the history extension provides further evidence of the potential advantage of focusing on the least volatile constituents in a given market,” according to S&P Dow Jones.
For more information on alternative index-based strategies, visit our smart beta category.