After a strong start to 2018 in January, February has served as reminder to fund shareholders that what goes up can also go down. Market volatility is nothing new and to rate ETFs, CFRA Research includes a standard deviation metric so investors can understand not just the reward potential, but also the risk.
Even though the worst might not be over, CFRA is not projecting the start of a new bear market, since we don’t forecast a recession. In 2018, CFRA sees real GDP rising 3.1% and S&P 500 EPS up more than 19%. As such, investors could benefit from staying with large cap strategies that have historically been less volatile.
PowerShares S&P 500 Low Volatility ETF (SPLV) holds the 100 least volatile stocks within the broader S&P 500 index regardless of sector representation and is rebalanced and reconstituted on a quarterly basis. In 2017, when risk was being rewarded in the equity market, SPLV’s 17% return was, not surprisingly, below the 22% for SPDR S&P 500 (SPY). However, the three-year annualized standard deviation for SPLV of 9.27 was 9% lower than SPY, while its beta was just 0.64 (SPY has a beta of 1).
Relative to SPY, SPLV was overweighted to industrials (19% vs. 10% at yearend) and financials (17% vs. 14%), but underweighted to technology (10% vs. 22%) stocks.
Meanwhile, iShares Edge USA Minimum Volatility (USMV) has sector exposure more aligned with the broader market as it seeks out the lowest volatility in each sector and is optimized. For example, technology (19%) is the largest sector exposure, while industrials (10%) and financials (9%) exposure was lower than SPLV; USMV is rebalanced and reconstituted semi-annually and can deviate from the broader market’s sector weightings by as much as 500 basis points.
USMV rose 19% in 2017, ahead of SPLV, but still behind SPY. The iShares ETF also has a lower annualized three-year standard deviation of 8.53, but a beta of 0.67, highlighting the importance of understanding the distinctions of these two similar sounding ETFs and the broader market.
USMV and SPLV combined have $21 billion in assets and each earns favorably low risk considerations and cost factors from CFRA based on our holdings and fund-level analysis. Their success in gathering assets has also encouraged other assets managers to offer low or minimum volatility ETF products in recent years.
For example, Fidelity Low Volatility (FDLO), JPMorgan US Minimum Volatility (JMIN) and Oppenheimer Russell 1000 Low Volatility Factor (OVOL) came to market since late 2016 and are rated by CFRA, but they do not have a three-year standard deviation.
The average large-cap core mutual fund CFRA rates had a three-year standard deviation of 10.18, in line with the 10.21 for SPY. Yet, using MarketScope Advisor and focusing on the funds with the lowest three-year standard deviation metric, investors can find some appealing, lower risk funds for consideration.