We love exchange-traded funds, because they make life simpler. Or they were supposed to. Once they exploded in number, it became a bit like trying to choose what to watch on YouTube. Yet the bigger problem was that as ETFs innovated, lazy investors just went with the standard index ETFs and forgot about them. In this process, they have missed some great innovations in low-volatility ETFs.
Such ETFs are a better play on your standard index ETFs, as they are low-volatility versions of these same indices. The concept behind low-volatility index ETFs is that they select a certain core group of stocks from the same broad index, but they choose the ones that have had the least volatility of the group.
Now comes the kicker: this doesn’t necessarily result in superior returns, but rather, superior risk-adjusted returns. Investors tend to ignore risk, and when you look at risk-adjusted data, low-volatility ETFs win almost every time.
So with that as a backdrop, here are three low-volatility ETFs that will help you win every time.
Low-Volatility ETFs That Win Every Time: PowerShares S&P 500 Low Volatility Portfolio (SPLV)
Expense Ratio: 0.25%, or $25 annually for every $10,000 invested
Take the S&P 500. The standard ETF there is the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). Buy the ETF, and you get a basket of 508 market-cap-weighted stocks. There’s plenty of diversification for you, but there’s also more volatility, mostly because the higher market-cap stocks tend to move the whole thing more than if they were equally weighted … or only had lower volatility stocks involved.
Well, the PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV) is worth looking at closely. Specifically, look at the Sharpe Ratio. Although not intended to be examined in a vacuum, it provides an excellent overall guide for risk-adjusted returns. The higher the Sharpe Ratio is, the more return you get in relation to risk.
The SPY has a Sharpe Ratio of 1.00, but SPLV has a ratio of 1.28. Plus, its five-year returns history shows it captures 75% of the S&P 500’s upside, but only 46% of the downside! Top holdings include: PepsiCo, Inc. (NYSE:PEP), Procter & Gamble Co (NYSE:PG) and AT&T Inc. (NYSE:T).
Low-Volatility ETFs That Win Every Time: PowerShares S&P MidCap Low Volatility ETF (XMLV)
Expense Ratio: 0.25%
How about mid-cap stocks? You better believe it! Once again, the popular kid is the iShares Core S&P Mid-Cap ETF (NYSEARCA:IJH). So you’d think that its 400-plus stocks would give it all this diversification and spread out your risk. It does, to a certain extent. Yet look at how it contrasts with the PowerShares S&P MidCap Low Volatility ETF (NYSEARCA:XMLV).
Over the last three years, the IJH has a Sharpe Ratio of 0.81, meaning you get less return for the risk the index undertakes. Meanwhile, XMLV has a Sharpe Ratio that blows it away: 1.38. This means you are getting something like a 57% improvement in return when factoring in risk. That doesn’t mean 57% higher returns, mind you, but 57% better performance when risk is factored in.
Not only that, but with top holdings like Endurance Specialty Holdings Ltd. (NYSE:ENH) and RenaissanceRe Holdings Ltd. (NYSE:RNR), XMLV captures 90% of the index’s upside and only 42% of the downside.
Low-Volatility ETFs That Win Every Time: SPDR Russell 2000 Low Volatility ETF (SMLV)
Expense Ratio: 0.12%
Moving on to small caps, we can pair off the iShares Russell 2000 ETF (NYSEARCA:IWM) and its low-volatility counterpart, the SPDR Russell 2000 Low Volatility ETF (NYSEARCA:SMLV).
I found it astonishing that IWM, despite having roughly 2,000 stocks, was still not as a better risk-adjusted choice. I had always assumed that diversification was the be-all, but the Sharpe Ratio is only 0.52. This was also surprising. I expected that small caps, which tend to have higher returns over time, would have a higher Sharpe Ratio, particularly because the diversification would balance out the risks associated with smaller stocks. Nope.
Amazingly, SMLV has a mere 154 stocks — including stocks like Curtiss-Wright Corp. (NYSE:CW) and Ameris Bancorp (NASDAQ:ABCB) — you might think that the far more concentrated degree of equities would increase volatility, even choosing low-volatility names. Yet, that’s not the case, and the Sharpe Ratio is 1.53 — far, far higher. It does this despite capturing 94% of the upside and 90% of the downside.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
