Despite the exuberance that helped propel the equities at the start of the year, ETF investors still funneled billions of dollars into defensive, factor-based strategies that tilt toward companies with a propensity for lower volatility.
The iShares MSCI USA Minimum Volatility ETF (Cboe: USMV) was among the most popular ETF plays so far this year, attracting $2.3 billion in net inflows year-to-date, while the Invesco S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) brought in $730 million in inflows, according to XTF data.
According to Morningstar, ETFs that try to pick less risky stocks have added $11.3 billion since the start of November, the Wall Street Journal reports.
“When you look at the different factors and where we are in the cycle, you still need exposure to stocks, but you may want to do it a little more defensively,” Larry Carroll, chief executive of Carroll Financial, told the WSJ, adding that he has picked out USMV for its exposure to a less volatile mix of U.S. stocks.
The low volatility strategy has also been outperforming. Over the past year, SPLV increased 10.3% and USMV gained 10.1% during the volatile year, with the S&P 500 only rising 3.8% in comparison.
“The performance was outstanding, and it came on people’s radar screens in a big way,” Nick Kalivas, senior equity ETF strategist for Invesco, told the WSJ. “We’re on the downside of the cycle, so there’s more of a hunger for risk-mitigation strategies.”
The different issuers and index providers arrive at a basket of low volatility stocks in varying fashions. SPLV holds the 100 S&P 500 members with the lowest trailing 12-month volatility.
“Each quarter, S&P ranks the constituents in the S&P 500 by their volatility over the past 12 months and selects the least volatile 100 for inclusion in the index. It then weights these constituents by the inverse of their volatility, so that steadier stocks receive larger weightings in the portfolio. This approach is laudably transparent, and it offers clean exposure to the low-volatility effect. But because there are no constraints on sector weightings or turnover, the fund can end up with large sector tilts that change over time. And because it does not consider valuations in its selection process, the fund can drift across the style box,” Morningstar analyst Alex Bryan said in a note.
USMV uses a different approach, somewhat more complex approach relative to traditional low volatility products, but has its advantages as well. Its risk model puts greater emphasis on more-recent data, which may be more predictive of future risk.
“It uses a holistic approach to reduce volatility, applies reasonable constraints to preserve diversification, and emphasizes stocks that have historically offered superior risk-adjusted performance. The index draws on the Barra Equity Model for estimates of each stock’s volatility, exposure to risk factors, and the covariances between them. Notably, the model uses each stock’s factor exposures, rather than its actual returns, to estimate its volatility and covariances,” Bryan said in a separate note.
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