A Multi-Faceted Approach to Volatility Reduction | ETF Trends

Low volatility is a standalone investment factor, but there are ways to implements it via a multi-factor approach. The Hartford Multifactor Low Volatility US Equity ETF (CBOE: LVUS) is an option for blending the benefits of reduced volatility with other perks.

LVUS tries to reflect the performance of the Hartford Multifactor Low Volatility US Equity Index, which tries to outperform a U.S. cap-weighted universe with up to one quarter less volatility over a complete market cycle.

“It is important to evaluate both the offensive characteristics (using factors in an attempt to enhance returns) and defensive characteristics of a multifactor ETF,” said Brian Kraus, head of investment consulting at Hartford Funds, in remarks sent to ETF Trends. “During periods of heightened volatility and uncertainty, we would expect those strategies that strike the right balance between offense and defense to emerge from a crisis in a more resilient manner than its peers.”

Beyond Low Vol

LVUS’s underlying benchmark goes beyond volatility reduction, including an optimization process that seeks diversification by applying minimum and maximum weightings of equity securities across a variety of measures, including sector, company, size, and other factors. The optimization process also seeks to avoid unintended factor risks by maintaining neutral to positive exposure to other potentially return-enhancing factors such as value, momentum, and quality at the portfolio level.

In today’s climate with the COVID-19 pandemic, political uncertainty, and geopolitical tensions, equity investors may encounter sudden risk-on events that could upend the bull market rally that has extended into its ninth year. Consequently, investors who still want equity market exposure but are wary of a sudden plunge may consider multi-factor, low-volatility ETFs to help smooth out a potentially bumpy ride.

“Prolonged asymmetric market returns can lead to policy allocation imbalance (i.e. if stocks go down and bonds go up for a while, if no action is taken, the stock/bond split will look a lot different than the original intent of the portfolio),” said Kraus. “The same can be said for equity risk factors. If the value continues to underperform and quality continues to outperform – if no action is taken to rebalance exposures between the two factors, an investor’s factor allocation can be distorted, relative to the initial intent of the portfolio.”

LVUS allocates 43% of its combined weight to industrial, consumer discretionary and technology stocks. The fund yields 2.69%

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.