Low volatility ETFs, such as the Invesco S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), are usually designed to be sector agnostic. That said, some sectors are lower volatility for longer periods of time, leading to higher weights in these funds. However, there are sector shifts.
SPLV tracks the S&P 500 Low Volatility Index, which is comprised of the 100 S&P 500 members with the lowest trailing 12-month volatility. While the fund is designed to be sector agnostic, it often features large allocations to utilities, financial services, and real estate stocks. Those sectors currently combine for about two-thirds of SPLV’s weight, according to Invesco data.
SPLV’s underlying index rebalanced last week, expelling 64 names while also making some significant sector-level adjustments.
“For context, the median annual turnover for the last 28 years has been 64%. This quarter’s turnover is notable not just for its size, but also because of some large shifts in sectoral allocation,” according to S&P Dow Jones Indices. “Low Vol’s weighting in Utilities fell by 21%, Real Estate by 16%, and Financials by 11%, while Health Care (+21%) and Consumer Staples (+13%) witnessed double-digit gains.”
Reasonable Adjustments
SPLV shedding some real estate and financial services exposure makes sense. Retail store closures forced by COVID-19 stoked increase volatility for the real estate sector in the first quarter while financials are being plagued by the Federal Reserve’s response to that scenario: low interest rates.
One of the primary objectives of low volatility ETFs, such as SPLV, isn’t to capture all of a bull market’s upside, but rather to capture less downside when markets swoon. What that means is that a fund such as SPLV, if behaving as expected, won’t be immune from equity market retrenchment when stocks decline, but it will fall less during rough periods.
“By design, Low Vol favors the least volatile sectors, with no arbitrary constraints. This latest rebalance is a good demonstration of how dynamic the index can be, and its size is a function of two things,” notes S&P Dow Jones Indices. “First, all factor indices are subject to drift. They best embody the factors they’re designed to track immediately after they’re rebalanced. In periods of high dispersion, factor drift is especially likely, and dispersion in the S&P 500 hit near-record levels in March.”
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.
For more on multi-factor strategies, visit our Multi-Factor 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.