The low volatility phenomenon is not exclusive to large-cap stocks, at least not in the world of exchange traded funds. Investors can use ETFs to skirt volatility across multiple market cap spectrums and that includes small-cap stocks.
The PowerShares S&P SmallCap Low Volatility Portfolio (NYSEArca: 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.
Small-caps are focused on the domestic economy and have less direct exposure to global geopolitical uncertainty and currency risks, as opposed to large-cap companies that have an international footprint, which may be affected by overseas risks and a strengthening U.S. dollar.
XSLV’s weighting methodology “can introduce some pretty big sector bets, which can be a source of risk, but the fund should hold up better than its parent benchmark during market downturns and should offer a better risk-reward trade-off over a full market cycle,” said Morningstar in a recent note.
At the sector level, XSLV is not excessively weighted to utilities and consumer staples stocks, two sectors often believed to be the cornerstones of low volatility ETFs. Actually, those groups are two of the ETF’s smallest sector allocations.
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Small-cap stocks were strengthening as traders renewed their outlook on the Trump administration’s pro-growth agenda. In recent weeks, U.S. markets have been roiled over uncertainty concerning President Donald Trump’s ability to push through pro-growth economic policies through Congress as the White House wades through political intrigue. However, the small-cap segment is recovering on expectations that the administration could overhaul the U.S. tax policy.
“Low-volatility stocks have historically offered better risk-adjusted performance than their more volatile counterparts. One possible reason for this is that investors may overpay for highly volatile stocks, which may offer a small chance for a large payout, and neglect more steady-eddy names, which are less likely to offer eye-popping returns, causing them to become undervalued,” according to Morningstar.
XSLV is up nearly 8% year-to-date and more than 6% over the past month.
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