Reducing The Small-Cap Risk Profile

Exchange traded funds have boosted the accessibility of the low volatility factor. Fortunately, that phenomenon is not reserved for large-cap stocks. Some small-cap funds focus on volatility-reduction techniques as well, including the popular PowerShares S&P SmallCap Low Volatility Portfolio (NYSEArca: XSLV).

XSLV takes the securities that exhibit the lowest volatility from the benchmark S&P SmallCap 600 Index. To be precise, XSLV is home to the 120 stocks from the S&P SmallCap 600 that have the lowest trailing 12-month volatility.

Looking ahead, the U.S. economy is still slowly expanding and the Federal Reserve is embarking on a tighter monetary policy outlook. Small-caps, though, can still navigate through a slowly rising rate environment. Smaller companies, which focus on U.S. markets, are less exposed to a stronger U.S. dollar as rates rise, which would more negatively affect larger corporations with a global footprint. Additionally, periods of rising rates also coincide with expanding economies, which often benefit smaller companies.

“So far, the fund’s approach has worked well. From its inception in February 2013 through January 2017, the fund exhibited about 13% less volatility and about 20% less market sensitivity than its parent index,” said Morningstar. “It also beat the benchmark by 124 basis points annualized during that time, largely because of more-favorable stock exposure in the financial-services industry.”