Dealing with uncertainty is just part of the game when it comes to investing. Nothing is ever clear when it comes to the future. However, the looming fiscal cliff deadline really has investors on edge.
Investors who are skeptical a deal can be reached between the Obama Administration and Congress have turned to low volatility exchange traded funds. When market uncertainty remains dominant, this strategy has proven it can generate returns in both an up and a down market.
"If 2012 was the year of the dividend ETF, 2013 may be the year of the low volatility ETF. The dividend play may be a bit skewed going into 2013 due to so many special dividends being paid prior to year-end and a possible exodus from dividend payers with dividend tax rates set to triple. At first glance, these two strategies should be vastly similar. Dividend stocks tend to offer lower volatility and juiced returns," Everyday Finance reports.
A recent study revealed that the strategy behind the S&P Low Volatility ETF (NYSEARCA:SPLV), which tracks the 100 lowest volatility stocks in the S&P 500 Index, performed better than the S&P 500 as a whole from 1991 to 2011, according to the report. The back-testing indicated that the low volatility strategy outperforms due to taking lower losses during bear markets, or volatile times, rather than outperforming.
SPLV is up 6.6% year-to-date, while the broad market SPDR S&P 500 (NYSEARCA:SPY) has gained 13.9% in 2012. Low-volatility ETFs can underperform in risk-on markets.
The index that SPLV tracks owns stocks based on 12-month trailing volatility. When volatility is high in a sector, that fund begins to cut back on the exposure. This way, when a sector begins to show signs of volatility, the index avoids those shares and allocates money in another place. The idea is to be out of the way when the bottom falls out of a sector, and SPLV has been able to do this with efficiency.
Furthermore, low-volatility ETFs have proven to have just as much merit as bond ETFs, without inflationary risk. Should inflation rise and interest rates respond alongside, bond investors get burned. Conversely, equities in this same situation pass the rising costs onto consumers, which improve earnings and can ultimately reverse effects of inflationary pressure.
"Indeed, fund providers have been quick to capitalize on the idea that you can invest for better than 0% in a savings account without the stress associated with the Dow falling 1000 points in a week. And low volatility funds have experienced reasonably solid results in 2012," Gary Gordon wrote for Seeking Alpha.
- iShares MSCI Emerging Markets Minimum Volatility (NYSEARCA:EEMV) up 14.9%
- MSCI All World Minimum Volatility (NYSEARCA:ACWV) up 9.6%
- MSCI USA Minimum Volatility (NYSEARCA:USMV) up 9.4%
S&P Low Volatility ETF
Tisha Guerrero contributed to this article.