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.
Low-volatility stocks historically offered more favorable risk/reward trade-off than the market due to investor behavior, which has induced mispricing. Riskier stocks typically exhibit greater upside potential than defensive stocks, which makes them more attractive to investors whom care about chasing after high returns. Consequently, these collective bets on risky stocks can cause these riskier bets to be overvalued and offer less attractive compensation for their risk than their more defensive counterparts, especially after an extended bull run.
Looking at the fund’s underlying holdings, USMV has greater tilt toward defensive sectors, including utilities, healthcare and consumer defensive, compared to the benchmark MSCI USA Index. The ETF also has greater exposure to real estate stocks and a smaller weight to more volatile sectors like energy, tech and financials.
For more information on factor-based investments, visit our Smart Beta Channel.