The low volatility factor is being glossed over this year in favor of growth and momentum, but that does not mean opportunity is lost with exchange traded funds such as the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV).
In fact, SPLV and the rival iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) hit new highs on Wednesday. USMV selects stocks based on variances and correlations while SPLV holds the 100 S&P 500 stocks with the lowest trailing 12-month volatility. Additionally, there could be catalysts that could renew investors’ affinity for low volatility ETFs, including the Federal Reserve.
“In addition to its impact on the economy, monetary policy can affect the health of a company’s balance sheet, access to capital and investment opportunities,” said Invesco PowerShares in a recent note. “Historically, there has been about a two-year lag between initial increases in the overnight federal funds rate and equity volatility, as shown in the chart below. Why is this germane now?”
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 ETFs also are not as dull as previously believed. For example, SPLV now allocates over 19% of its combined weight to technology and consumer discretionary stocks and cyclical industrials are the ETF’s largest sector allocation at 17%. As Invesco PowerShares notes, credit spreads could also factor into bringing investors back to low volatility funds.
“Credit spreads — the difference in yield between corporate securities and US Treasuries — are a third factor influencing equity volatility,” according to PowerShares. When the cost of corporate debt increases, it becomes more expensive for companies to access capital. Investment costs can rise as a result, which can make it difficult to return money to shareholders. By contrast, falling credit spreads, which imply lower corporate yields, make for less-costly access to capital. It then becomes easier to return money to shareholders.”
Year-to-date, SPLV has added nearly $97 million in new assets, but over the past 90 days, that figure has swelled to $178.1 million.
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