Low-Volatility ETFs Can Offer Steady Gains

If there’s two things investors love, it’s consistency and reliability — two attributes that deftly describe the trend of exchange-traded funds that track low volatility stocks.

Low-Volatility ETFs Can Offer Steady Gains

This unique category of the ETF universe has rapidly expanded in recent years through a combination of persistent fund flows and sector momentum. The factors that ultimately shape low-volatility indexes have proven to offer attractive characteristics for conservative investors who want equity exposure without the downside risk of a typical broad-based benchmark.

One leading fund in this group is the iShares Edge MSCI Min Vol USA ETF (BATS:USMV), which has amassed nearly $14 billion in total assets. USMV is composed of nearly 200 large- and mid-cap U.S. stocks with characteristics of reduced historical price volatility versus their peers.

In short, it’s a cross section of the U.S. stock market that has demonstrated less downside risk over a short look-back period.

The USMV portfolio is multisector in nature, with caps placed on the maximum allocation for any single group. At present, the top holdings include healthcare, technology and consumer staples companies such as McDonalds Corporation (NYSE:MCD) and Johnson & Johnson (NYSE:JNJ). It also charges a very reasonable expense ratio of 0.15%, making it suitable as a long-term core holding in certain portfolios.

On a year-to-date basis, USMV is slightly outpacing the gains of the broad-based SPDR S&P 500 ETF Trust (NYSEARCA:SPY) with a total return of 11.2% vs. 10.9%. It also has a lead on the SPY over the last three years as well.

The high demand for innovation in the category has created a great number of ways to slice varying low-volatility ETFs. Other top funds include the PowerShares S&P 500 Low Volatility ETF (NYSEARCA:SPLV) and PowerShares S&P 500 High Dividend Low Volatility Portfolio (NYSEARCA:SPHD). There is also the iShares Edge MSCI Min Vol EAFE ETF (BATS:EFAV) to consider for those who want a similar strategy directed towards international equities. I could easily name 10 more with varying flavors of global exposure, dividends or some other tangential quality.

Having owned and observed these ETFs as core portfolio holdings, I can attest to their strengths. They work well to provide low-cost exposure to a subset of high quality stocks. They are also fantastic for conservative investors who would normally be scared out of owning a benchmark-like index with far more downside risk.

Nevertheless, they have certain drawbacks as well. The same factors that create the low-volatility screens also lead to herding and potentially overcrowding in certain sector groups. The methodology is such that stocks with the lowest volatility are consistently momentum driven and can suffer from higher valuations than comparative indexes.

That’s not necessarily a bad thing if the trend for those overweight sectors continues to consistently seek out higher prices. Like any smart-beta index, funds like USMV and SPLV will ultimately experience periods of outperformance and others where their more conservative nature doesn’t fit the market’s mood.

The Bottom Line on Low-Volatility ETFs

This is certainly one of those times where smooth sailing, low costs and sector makeup are in the sweet spot for low-volatility ETFs. Yet, some fundamentals such as price/earnings and price/book suggest abnormally high valuations on a relative and absolute basis.

No matter your outlook on these funds, they have certainly lived up to their namesake and offer excellent opportunities for investors that understand their structural boundaries.

David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. Click here to download their latest special report, The Strategic Approach to Income Investing. At the time this article was written, some clients of FMD Capital Management owned shares of EFAV.

Article printed from InvestorPlace Media, https://investorplace.com/2017/09/low-volatility-etfs-pump-steady-gains/.

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