Tom Lydon
Tom Lydon, president of Global Trends Investments, Irvine, California. He is editor of ETFTrends.com and author of iMoney: Profitable ETF Strategies for Every Investor (FT Press).
After the investment world’s wild ride of the past several years, many investors are aching for more tranquility. Wall Street is addressing that yearning with a range of new exchange-traded funds (ETFs)* that are designed to smooth out the wild swings. More than a dozen of these low-volatility ETFs now are available.
And lower volatility doesn’t mean that you have to settle for lower returns. Over the past decade, the Standard & Poor’s 500 Low Volatility Index returned 7% annualized versus 4% for the S&P 500 stock index.
Here’s how low-volatility ETFs can be right for you…
By investing in low-volatility stocks, these ETFs can reduce the impact of the market’s jolts. Example: When the S&P 500 moves up or down by 1%, a low-volatility version of the index tends to move 0.7% in the same direction.
Major investment companies that offer low-volatility ETFs, such as Blackrock, Russell and Invesco, focus on several factors to choose the low-volatility stocks that make up the ETFs. These factors include…
In response to these considerations, low-volatility ETFs often load up on stocks that are in stable sectors, such as household goods and utilities that consumers don’t eliminate even during difficult economic times. But even when various low-volatility ETFs seem similar, they are not simply clones of one another. They cover slightly different indexes…reevaluate their holdings at different intervals…and sometimes impose restrictions on how much they allocate to particular countries or sectors.
Important: Despite their appeal as safer investments with possibly better returns, low-volatility ETFs are all-stock offerings, which means that they still will be significantly riskier than funds that include bonds or a mix of bonds and stocks in their portfolios. Also, you are better off holding these ETFs in tax-deferred accounts, since most adjust their portfolios several times a year, which is likely to lead to higher turnover and more tax implications than many index funds.
Finally, if you invest in a low-volatility ETF, you probably will need to adjust your expectations downward in bull markets. While these ETFs can provide some protection and returns in down times, they are unlikely to keep pace with the overall market when stocks are rising sharply.
Low-volatilty ETFs can be very useful tools to help you accomplish the following…
Reduce overall risk without getting out of stocks completely. During rough times, investing in low-volatility ETFs is a less drastic alternative than trying to time the market by shifting assets to cash or bonds.
Gain exposure to riskier asset classes that can boost your long-term returns. For example, if you are a retiree invested mostly in bonds but still need substantial growth in your portfolio, you may feel more comfortable adding a low-volatility foreign stock fund than a standard one.
Here are a variety of low-volatility ETFs for you to consider. They all are from reputable money-management firms that use a disciplined selection process…
PowerShares S&P 500 Low Volatility Portfolio (SPLV). The largest of the low-volatility ETFs, it has attracted nearly $2 billion in assets. It consists of the 100 stocks from the S&P 500 with the lowest volatility over the past 12 months. Every three months, the portfolio is reevaluated and stocks are replaced if necessary. Recent share price: $28.11.
Russell 1000 Low Volatility ETF (LVOL) picks from the 1,000 largest US companies and can hold up to 200 stocks. It uses more complex criteria than the PowerShares ETF to choose stocks and keeps a tighter rein on volatility in both up and down markets. To ensure it remains focused on low-volatility stocks, the portfolio is reconstituted every month. Recent share price: $53.29.
Russell 2000 Low Volatility ETF (SLVY) currently is the only small-cap ETF devoted to low-volatility stocks. It holds up to 400 of the least volatile stocks in the Russell 2000. The ETF has about 18% of its portfolio in real estate and utilities, and it is reconstituted every month. Recent share price: $57.57.
iShares MSCI EAFE Minimum Volatility Index (EFAV) tracks the MSCI EAFE Minimum Volatility Index, which attempts to create the least volatile portfolio of up to 200 stocks from the MSCI EAFE Index. That index includes developed nations in Europe, the Australia region and the Far East. The ETF reevaluates and reconstitutes its portfolio only twice a year. In attempting to reduce the ETF’s volatility, it imposes certain constraints that its competitors don’t, such as limiting the percentage of assets that can go into any one sector or country. The ETF also has one of the lowest annual expense ratios of any low-volatility ETF, just 0.2%. Recent share price: $53.85.
PowerShares S&P International Developed Low Volatility Portfolio (IDLV). This ETF tracks the 200 stocks in the S&P Developed Ex.-US-Korea LargeMidCap Index** that have exhibited the lowest volatility over the past 12 months, with 16% of its portfolio currently devoted to Canadian firms. The ETF is rebalanced and reconstituted quarterly and is a more conservative offering than the iShares MSCI EAFE Minimum Volatility Index ETF. (**Although South Korea sometimes is regarded as a developed country, it is not included in this index because of the high volatility of its stock market.) Recent share price: $27.77.
*ETFs are funds that typically track a particular investment index but can be bought and sold on an exchange like individual stocks. They tend to have lower annual expenses than comparable mutual funds.
Source: Tom Lydon, president of Global Trends Investments, Irvine, California, which manages more than $80 million of assets in all-ETF portfolios. He is founder of ETFTrends.com and coauthor of iMoney: Profitable ETF Strategies for Every Investor (FT Press).
