Small-cap equities and exchange traded funds are leadership groups this year, but often times, investors have to deal with more volatility with smaller stocks relative to large caps. The Invesco S&P SmallCap Low Volatility Portfolio (NYSEArca: XSLV) is one ETF that helps limit the volatility burden often associated with smaller stocks.

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.

Among smart beta ETFs dedicated to individual investment factors, low volatility products have been popular with conservative investors based on the premise that emphasizing a low volatility strategy can help reduce a portfolio’s downside potential.

The trade-off with ETFs like XSLV is that these funds are designed more to be less bad in bear markets than they are to capture to all of the upside during a bull market. Still, XSLV is up nearly 8% year-to-date and hit an all-time high last Friday.

Risk Reduction Strategy

“The most common statistical measures of risk that low-volatility funds use to select stocks are standard deviation of returns and market beta,” said Morningstar in a recent note. “Some also include fundamental measures of risk, such as volatility of earnings or leverage. However, one approach isn’t necessarily better than the others; while incorporating fundamental measures of risk can paint a more complete view of risk, they can also dilute the portfolio’s exposure to the least-volatile stocks in the market.”

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