Maybe it’s a little greedy to complain about a market that has delivered more than 6% in total returns through just four months into 2017. The S&P 500 has done well, but it has been a nauseating ride … though it hasn’t been so bad for investors in low-volatility exchange-traded funds.
For the uninitiated, low-volatility ETFs are pretty much exactly what they sound like — they’re groups of stocks that are selected in a way that should reduce the beta of the fund, meaning that the daily swings of the broader market shouldn’t be as sharp in these funds.
And the best ETFs in the low-volatility space are able to do this without sacrificing performance.
Several low-volatility ETFs focusing on large-cap stocks have actually delivered better returns than the S&P 500 this year, and they’ve done so with far less “wiggle.” Take a look at the chart below comparing a low-volatility fund (orange line) and the SPDR S&P 500 ETF Trust (NYSEARCA:SPY):
How do they do it? Typically, low-volatility strategies screen for relative volatility versus peers, but also look for other measures of quality, whether it’s offering a dividend or maintaining positive earnings.
Today, we’ll look at some of the best low-volatility ETFs in the space that can replace a few different themes in your portfolio, such as large-cap growth, international stocks and even small caps.
Best Low-Volatility ETFs: iShares Edge MSCI Minimum Volatility USA ETF (USMV)
Expenses: 0.15%, or $15 annually for every $10,000 invested
The orange line on the chart you just looked at belongs to the iShares Edge MSCI Minimum Volatility USA ETF (NYSEARCA:USMV). In other words, the USMV is beating the market so far in 2017, and it’s doing so with a lower number of antacid tablets popped per investor.
The USMV looks at the top 85% of stocks by market capitalization in selecting its holdings, but ultimately is a large-cap stock fund with some mid- and very little small-cap exposure. The fund uses a black-box (read: the details are kept close to the chest) method of selecting stocks perceived to have the least amount of risk, then doubles up on protection by weighting the stocks in a way that further minimizes risk.
Here, no industry can have more than a 25% weighting within USMV, and it’s no surprise to see consumer staples with a heavy presence at 14.2% of the fund. Healthcare, which has calmed down a bit over the past few months, tops it at 19.4%, and investors might be surprised to see information technology (16.4%) and financials (11.2%) with double-digit weights.
Moreover, no stock has more than a 1.5% weight at the moment. Top holdings Automatic Data Processing (NASDAQ:ADP), PepsiCo, Inc. (NYSE:PEP) and AT&T Inc. (NYSE:T) together make up less than 5% of the fund.
This results in a very balanced fund with little single-stock risk, and perhaps a smaller dividend than you’d expect, at 1.8%. Still, USMV has kept pace with the S&P 500 since its inception in 2011, delivering a little outperformance in some periods, while underperforming in others.
But it’s a smoother ride, as USMV sports a beta of 0.7. (Any beta less than 1 is considered less volatile than the broader market.)
Best Low-Volatility ETFs: PowerShares S&P 500 High Dividend Low Volatility Portfolio (SPHD)
The low dividend on USMV is, as it turns out, a fairly common shortcoming among low-volatility ETFs.
In fact, only a few low-volatility ETFs — most of them internationally focused — deliver more income than the PowerShares S&P 500 High Dividend Low Volatility Portfolio (NYSEARCA:SPHD) and its 3.1% yield.
The SPHD takes the S&P 500 and filters it down, based on those exhibiting the least volatility over the past 12 months, to a group of 50 high-income stocks. The resulting portfolio has some things you’d expect … and some things you might not.
For instance, more than 22% of the portfolio is in utility stocks, and another 11% is in consumer staples. No one’s shocked to see the likes of Philip Morris International Inc. (NYSE:PM) or FirstEnergy Corp. (NYSE:FE) in a basket of low-volatility dividend stocks.
However, real estate (18.6%) and technology (9.8%) both take up a significant amount of portfolio space, despite the fact that both sectors can move and shake with the best of them. Top holding Iron Mountain Incorporated (Delaware) REIT (NYSE:IRM) — a data backup and records management real estate investment trust — is something of a play on both.
While SPHD is certainly defensive in nature, it can perform during bull-market runs too. The ETF trails the SPY in pure movement by less than 5 percentage points since its inception in late October 2012, but thanks to its superior dividends, it has actually outperformed by 5 percentage points.
Best Low-Volatility ETFs: SPDR SSGA US Small Cap Low Volatility Index ETF (SMLV)
You know the deal you’re making when you invest in small-cap stocks: You brace your stomach for a series of gut-wrenching lurches in exchange for much better growth potential than you get from mid- and large-cap stocks.
Not so with the SPDR SSGA US Small Cap Low Volatility Index ETF (NYSEARCA:SMLV).
The SMLV targets small-cap companies that exhibit low volatility, which results in a portfolio of about 430 holdings — much slimmer than the nearly 1,950 holdings in the Russell 2000-tracking iShares Russell 2000 ETF (NYSEARCA:IWM).
But it has the IWM beat where it counts.
Since inception in February 2013, the SMLV has outperformed the IWM on a total-return basis, 76.3% to 61.9%. That’s thanks in large part to a 2.4% dividend that’s nearly double the Russell 2000 ETF, which yields 1.3%. See, while people typically associate small caps with fast-moving tech or biotech stocks, they also include things like mortgage REITs, such as MFA Financial, Inc. (NYSE:MFA) and Apollo Commercial Real Estate Finance Inc (NYSE:ARI) that yield north of 9% and find themselves within SMLV’s top 10 holdings.
Meanwhile, SMLV has a beta of just less than 1, versus the IWM’s 1.2, meaning this small-cap ETF behaves more like a large-cap fund. That’s good for the nerves.
Best Low-Volatility ETFs: iShares Edge MSCI Min Vol EAFE ETF (EFAV)
Expenses: 0.2% (includes 12-basis-point fee waiver)
You can typically ride single-country ETFs to big multiyear gains as international fates ebb and flow.
Take the PowerShares India Portfolio (ETF) (NYSEARCA:PIN), which has ridden the country’s expanding economy to 36% gains from their February 2016 lows, beating the pants off the S&P 500 (22%) in that time. Or take the iShares MSCI Chile Capped ETF (NYSEARCA:ECH), which at 16% year-to-date gains has more than doubled U.S. stocks in that time.
However, broader international ETFs like the Vanguard FTSE Europe ETF (NYSEARCA:VGK) or the iShares MSCI EAFE Index Fund (ETF) (NYSEARCA:EFA) have, for the better part of a decade, operated in a terrible nether-realm in which they don’t produce big, tradable runs like single-country ETFs, nor do they provide the more steady upward run of U.S. stocks. Since the beginning of 2011, the SPY has run up 90% versus just 9% to 10% gains for the VGK and EFA, respectively.
The iShares Edge MSCI Min Vol EAFE ETF (NYSEARCA:EFAV) has been more effective despite (or maybe thanks to) its focus on lower-volatility stocks. EFAV invests in more than 220 stocks across Europe, Australasia and the Far East, with heavy single-country weightings in Japan (28.3%), the U.K. (16.2%) and Switzerland (13.6%). Holdings are a who’s who of stodgy stocks, including food multinational Nestle SA (ADR) (OTCMKTS:NSRGY) and healthcare giant Roche Holding Ltd. (ADR) (OTCMKTS:RHHBY).
Since its inception, EFAV has outperformed EFA, 8% to 6.9% annually, which is a lot more than you’d expect from a fund simply meant to smooth out the bumpy spots. Though this Edge fund does that, too, offering a beta of just 0.7% compared to the EFA’s 1.1%.