Among investment factors, low volatility has been a star and among the ETFs providing exposure to low volatility stocks, the iShares Edge MSCI Minimum Volatility USA ETF (USMV) is shining with a year-to-date gain of just over 24%.

USMV seeks the investment results of the MSCI USA Minimum Volatility (USD) Index, which measures the performance of large and mid-capitalization equity securities listed on stock exchanges in the U.S. that, in the aggregate, have lower volatility relative to the broader U.S. equity market.

When evaluating a low volatility ETF, USMV or otherwise, investors should consider both upside and downside capture ratios.

“The concept of upside/downside capture is fairly simple. ‘Upside’ is defined as periods when the market earned positive returns, while ‘downside’ refers to periods when the market earned negative returns,” said BlackRock in a recent note. ‘Capture’ indicates how much an investment participated in the market return. All else equal, it is considered desirable to capture more than 100% of the market’s upside (increase more), and less than 100% of the downside (decline less).”

Inside USMV’s Risk Factors

USMV selects 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.

“When we say that US minimum volatility has captured 80% of the upside of the S&P 500 but only 59% of the downside, many investors assume that means the strategy has lagged but with lower risk,” according to BlackRock. “Yet, since its inception in 2008, minimum volatility has outperformed the S&P 500 by 2% annualized.”

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.

“Losing less in 2019, minimum volatility returns have compounded to better returns in aggregate over the year,” said BlackRock. “This idea of winning by losing less translates into the longer-term results of minimum volatility as well. In fact, by capturing the lion’s share of the upside but significantly mitigating the downside, minimum volatility has historically been able to beat the market’s return since inception, while also delivering on risk reduction.”

For more information on factor-based investments, visit our Smart Beta Channel.

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.

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