Whenever the topic turns to market volatility — and its impact on investors’ portfolios — I’m reminded of a simple, but powerful, metaphor from PIMCO CEO Mohamed El-Erian. “Think of the image of a car on a bumpy road to an uncertain destination that has already used up its spare tire,” he said. “The cash reserves of people have been eaten up by the recent market volatility.”
That, in a nutshell, explains why when the going gets tough, the tough get defensive. The eurozone crisis, a slowdown in China’s growth and uncertainty about the U.S. economy falling off the “fiscal cliff” are creating a perfect storm for investors. Case in point: Trading in the CBOE Volatility Index (VIX) has gone wild lately, with June 2012 trading in VIX futures up 85% over this time last year.
That’s a challenge for investors seeking to avoid getting motion sickness from the current roller-coaster market. One good defensive play for jittery investors right now is in low-beta ETFs.
Simply put, beta is a measure of a stock’s volatility as it relates to the broader market. Stocks with a beta lower than 1 are less prone to volatility than the overall market; those with betas more than 1 tend to be more volatile. Beta also is a way of quantifying risk and reward because low-beta stocks tend to have lower returns in exchange for lower risk.
While you always can simply add individual low-beta stocks to your portfolio, ETFs offer advantages over that approach — most notably diversification. Because they trade over an exchange like stocks, investors can still take advantage of intraday price moves. And ETFs tend to have lower expense ratios and minimum investments than mutual funds.
Here are 4 low-beta ETFs to guard against volatility:
iShares Barclays TIPS Bond Fund ETF
If you doubt the Federal Reserve’s ability to keep inflation in check, consider iShares Barclays Treasure Inflation Protected Securities Bond Fund ETF (NYSE:TIP). The Barclays TIP ETF has some advantages for fixed-income investors at or nearing retirement, such as the interest income and a safe haven inflation hedge other than commodities and precious metals.
TIP’s underlying index includes all publicly issued, U.S. Treasury investment-grade, inflation-protected securities with at least $250 million in outstanding face value and one year left until maturity. With about $23 billion in assets, TIP has a tiny beta of just 0.1. It also has a current dividend yield of 2.7% and a smaller-than-average expense ratio of 0.2.
iShares Dow Jones U.S. Utilities Sector Index Fund
If you’re looking for “dull darlings,” utility ETFs like iShares Dow Jones U.S. Utilities Sector Index Fund (NYSE:IDU) quickly come to mind. Utility ETFs rallied amid all of last year’s volatility, but started 2012 a little flat. Market uncertainty has reminded investors that utilities offer low volatility and stable, attractive dividends.
IDU’s top holdings include Duke Energy (NYSE:DUK), Southern Co. (NYSE:SO), Exelon (NYSE:EXC) and Dominion Resources (NYSE:DOM). IDU has a solid beta of 0.5 and a current dividend yield of nearly 3.3%. Its expense ratio is 0.47.
PowerShares Dynamic Food & Beverage Portfolio
PowerShares Dynamic Food & Beverage Portfolio (NYSE:PBJ) is another good pick. Even in uncertain times, people need to eat — that’s the simple value proposition of PBJ, which comprises food and beverage company stocks.
PBJ’s top holdings include Monsanto (NYSE:MON), Whole Foods (NASDAQ:WFM), Hershey (NYSE:HSY) and Coca-Cola (NYSE:KO). The expense ratio is a little on the high side at 0.63, but the beta remains under one at 0.7. Plus, it has a year-to-date return of nearly 6.4% — higher than both of the previous picks — and a current dividend yield of about 1%.
iShares Dow Jones US Pharmaceuticals Index Fund
Now that the Supreme Court has upheld most of the Obamacare health reform law, much of the uncertainty surrounding many Big Pharma stocks will start to fade and iShares Dow Jones US Pharmaceuticals Index Fund (NYSE:IHE) is looking better and better. The individual mandate will deliver a lot more drug buyers for pharmaceutical companies. That will help offset losses from blockbuster drugs that are losing patent protection.
IHE’s top holdings include Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE), Merck & Co. (NYSE:MRK) and Abbott Labs (NYSE:ABT). IHE has a beta of 0.7, $402 million in assets, a year-to-date return of nearly 16% and a current dividend yield of 1.2%. The expense ratio isn’t too bad either, at 0.47.
As of this writing, Susan J. Aluise did not hold a position in any of the securities named here.