The recent market volatility and precipitous slide in stock prices shines new light on low-volatility ETFs, a growing segment of the investment securities market.
But do low-volatility ETFs really minimize the most extreme of price fluctuations? And if so, what is the best use of low-volatility ETFs in an investment portfolio?
Let’s take a look under the hood and see how these alternative investment choices work –and if they can be a good fit in your investment strategy.
What Are Low-Volatility ETFs?
As their name implies, low-volatility ETFs will seek to hold a number of securities –usually from a benchmark index –that are less volatile in relation to other securities in the index.
For example, PowerShares S&P 500 Low Volatility Fund (NYSEArca: SPLV) targets 100 of the least volatile stocks in the S&P 500 index. Instead of allocating the portfolio assets by a cap-weighted measure (as with conventional S&P 500 index funds) SPLV weights the holdings so that the least volatile stocks receive the highest weighting.
The top holdings in SPLV are Clorox (NYSE: CLX), Airgas (NYSE: ARG)and Coca-Cola (NYSE: KO).
There are only about 30 low-volatility ETFs on the market now, and most of them have only been around for a few years. Therefore, with the lack of a long-term track record, it’s difficult to say with confidence whether or not low-volatility ETFs are more than just a good idea in theory.
SPLV is the oldest low-volatility ETF and it’s been on the market for just under five years. While the market has seen some volatility in the past few years – and especially in mid-2015 and early 2016 –it may need more time to prove its worth.
However, there is some evidence that shows promise for SPLV and other low-volatility ETFs.
How Low-Volatility ETFs Have Performed
If we again use SPLV as a litmus test for value in the low-volatility ETF arena, we can look back over the past few years, when volatility has spiked to high relative levels.
In the first four full calendar years of its existence, SPLV lagged in performance in 2012 and 2013, when volatility was average to low, but beat the S&P 500 in 2014 and 2015, when volatility increased as investors began to fret a rise in interest rates. Here’s a quick breakdown in price movement:
And the 2016 year-to-date performance through Jan. 22 has SPLV at negative 4.3%, which compares to negative 6.7% for the S&P 500.Another widely held low-volatility ETF, iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) showed almost identical results.
From this perspective, low-volatility ETFs appear to be the genuine article: They offer investors a way to achieve reasonable returns with lower volatility.
Are Low-Volatility ETFs Right For You?
While low-volatility ETFs appear to provide investors what the product the name suggests, I believe that they are nothing more than an old idea repackaged in a new way. In other words, investors can create their own “low volatility” portfolio themselves, or they can simply buy a balanced fund.
For example, Vanguard Balanced Index Fund (VBINX), which is a blend of roughly 60% stocks and 40% bonds, offers low volatility compared to a stock index. It’s beating SPLV year-to-date in 2016.
Furthermore, most low-volatility ETFs end up looking and performing similar to value stock funds or a deep value stock like Berkshire Hathaway (NYSE: BRK-B).
Also, many investors do not place the minimization of volatility as their first priority in investing; they want to achieve the best returns over time with a portfolio that is suitable for their risk tolerance.
The bottom line is that minimizing volatility and producing reasonable long-term returns in a portfolio can be simply achieved by applying the timeless investing concepts of diversification and dollar-cost averaging.
However, low-volatility ETFs can be wisely used as a core holding in a diversified portfolio as part of an investor’s overall strategy.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities. Under no circ*mstances does this information represent a recommendation to buy or sell securities.
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FAQs
If you're looking to get back into the market in a responsible way, or if you're simply looking to rejigger your portfolio to reflect the new reality on Wall Street, low-volatility ETFs are an interesting option. They allow investors access to the stock market, but with a lower risk profile than the typical index fund.
Are low volatility ETFs good? ›
Low volatility investing has become one of the most popular forms of factor investing, evidenced by the ETFs USMV and SPLV managing over $40 billion combined. The popularity of these funds primarily comes from low volatility's long-term track record against the S&P 500.
Is it a good idea to invest in low volatility strategies? ›
Studies show that low volatility stocks, despite being less risky, outperform their benchmarks over time. This challenges the conventional wisdom that investors need to take on more risk to get higher returns.
Is it better to have higher or lower volatility? ›
Many day traders like high-volatility stocks since there are more opportunities for large swings to enter and exit over relatively short periods of time. Long-term buy-and-hold investors, however, often prefer low volatility where there are incremental, steady gains over time.
How do minimum volatility ETFs work? ›
A min vol ETF (as well as other min vol investment vehicles) attempts to reduce exposure to volatility by tracking indexes that aim to provide lower-risk alternatives to other riskier investments.
What is the best low volatility ETF? ›
The largest Low Volatility ETF is the iShares MSCI USA Min Vol Factor ETF USMV with $23.72B in assets. In the last trailing year, the best-performing Low Volatility ETF was TPSC at 16.20%. The most recent ETF launched in the Low Volatility space was the THOR Low Volatility ETF THLV on 09/12/22.
Why do investors dislike volatility? ›
A highly volatile security hits new highs and lows quickly, moves erratically, and has rapid increases and dramatic falls. Because people tend to experience the pain of loss more acutely than the joy of gain, a volatile stock that moves up as often as it does down may still seem like an unnecessarily risky proposition.
Why do low volatility stocks outperform? ›
Low volatility stocks are typically found in defensive sectors and have more predictable cash flows, leading them to exhibit lower valuation uncertainty. Thus, they portray bond-like characteristics, while investors are also likely to use them as replacements for bonds given that they typically pay out dividends.
Why is volatility bad for portfolio? ›
There are several ways to measure volatility, including beta coefficients, option pricing models, and standard deviations of returns. Volatile assets are often considered riskier than less volatile assets because the price is expected to be less predictable.
How much volatility is good for stock? ›
As an investor, you should plan on seeing volatility of about 15% from average returns during a given year.
Options traders can trade volatility and earn profits but this requires a set of strategies. Common strategies to trade volatility include going long puts, shorting calls, shorting straddles or strangles, ratio writing, and iron condors.
Is volatility good for day trading? ›
If the price moves a lot in a day, especially with lots of volume, this means that a trader can enter and exit the position easily. This is one reason why volatile stocks are so popular for day trading, in particular. A volatile stock is one whose price fluctuates by a large percentage each day.
Is high volatility bullish or bearish? ›
When applied to stock markets, a bearish market will show a high implied volatility rate as opposed to a bullish market, where implied volatility will be low. The primary reason behind this is, in a bullish market, investors expect prices to increase over time and therefore, IV goes down.
What is the safest ETF? ›
Vanguard S&P 500 ETF
Exchange-traded funds (ETFs) are one of the safer types of investments out there, as they require less effort than investing in individual stocks while also increasing diversification.
What does low volatility ETF mean? ›
Low volatility ETFs are Exchange Traded Funds (ETFs) designed to exploit the volatility anomaly. These usually replicate popular publicly available indices, such as MSCI Minimum Volatility Indexes or the S&P 500 Low Volatility index, at relatively low cost.
What is the best ETF to invest in? ›
7 Best ETFs to Buy Now
| ETF | Expense Ratio | Year-to-date Performance |
|---|
| Global X Copper Miners ETF (COPX) | 0.65% | 26.2% |
| YieldMax NVDA Option Income Strategy ETF (NVDY) | 1.01% | 12.9% |
| iShares Semiconductor ETF (SOXX) | 0.35% | 14.9% |
| Simplify Interest Rate Hedge ETF (PFIX) | 0.50% | 22.9% |
3 more rows2 days ago
What is TSLY's 20-day moving average? TSLY 20-day moving average is 14.86, which suggests TSLY is a Buy. What is TSLY's 50-day moving average? TSLY's 50-day moving average is 15.24, which suggests TSLY is a Buy.
Why ETF is less risky? ›
Diversification. One ETF can give investors exposure to many stocks from a particular industry, investment category, country, or a broad market index. ETFs can also provide exposure to asset classes other than equities, including bonds, currencies, and commodities. Portfolio diversification reduces an investor's risk.
But do low-volatility ETFs really minimize the most extreme of price fluctuations? And if so, what is the best use of low-volatility ETFs in an investment portfolio?
