With market volatility nearly non-existent this year and with investors displaying a preference for higher beta sectors, some low volatility exchange traded funds are seeing investors depart for less conservative destinations.
This year, investors have drifted away from once popular low volatility ETFs such as the and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV), but the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) has added new assets. USMV selects stocks based on variances and correlations while SPLV holds the 100 S&P 500 stocks with the lowest trailing 12-month volatility.
One of the primary issues currently facing low volatility ETFs such as SPLV and USMV is that U.S. stocks continue moving higher, encouraging some investors to chase performance. Low volatility strategies typically do not capture all of a bull market’s upside, but these funds often see less downside when markets slide.
“Generally, this is what investors should expect. Low-volatility portfolios tend to offer above-average downside protection in exchange for below-average upside participation. Over the long term, this should translate to better risk-adjusted (not absolute) returns for investors in low-volatility stocks,” according to Morningstar.
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.
MSCI, the index purveyor for USMV’s underlying benchmark, highlights beta, the degree to which stocks tend to move in the same direction as the market, along with dividend yields. Low-vol ETFs have been strengthening this year as they limited downside risk when the markets slipped and strengthened on increased defensive bets during turbulent times.
Year-to-date, investors have pulled about $74.3 million from USMV while SPLV has seen inflow of almost $473 million. In the third quarter, USMV has lost $316.2 million in assets.
“The net result is another testament to the fact that we are our own worst enemies. From May 1, 2016, through June 30, 2017, USMV generated an annualized return of 12.61% for investors. Meanwhile, investors’ collective cash-flow-weighted return was negative 0.63%. This yawning behavior gap shows there is ample room for improvement in the manner in which investors use these funds,” according to Morningstar.
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