3 Types Of Low-Volatility ETFs

by: Tom Lydon

The string of financial crises in recent years has been etched on the market's psyche. As a way to mitigate oscillations in their portfolios, investors are turning to a number of low-volatility exchange traded fund options to hedge against potential risks down the road.

Low-volatility strategies tend to underperform during a bull market, but during times of market uncertainty, these types of investments can provide decent risk-adjusted returns.

One of the most popular options has been the PowerShares S&P 500 Low Volatility ETF (NYSEARCA:SPLV), which garnered almost $3.1 billion since its launch in May 2011. SPLV holds the 100 stocks of the S&P 500 Index that have shown the lowest realized volatility over the last year.

Still, with the ever-expanding universe of ETFs, investors have other tools on hand. For instance, the Direxion S&P 500 DRRC Volatility Response Shares (NYSEARCA:VSPY) tackles the volatility issue through another methodology as a way to generate a greater risk/return portfolio.

Specifically, VSPY mitigates risk by changing its equity exposure to the S&P 500 based on a volatility index. The fund's equity exposure is calculated by dividing the target volatility of 15% by the S&P 500′s volatility. Consequently, depending on the volatility level, VSPY can take on a cash position in T-Bills of 0% to a little over 80%.

More recently, two "tail" or "downside" hedged ETFs have been launched: the First Trust CBOE S&P 500 VIX Tail Hedge Fund (NYSEARCA:VIXH) and PowerShares S&P 500 Downside Hedged Portfolio (NYSEARCA:PHDG). Both funds will shift their positions in the S&P 500 and call options on VIX futures, based on current market volatility.

The tail hedging strategy protects a portfolio from extreme market oscillations due to unpredictable, random and unexpected events, or "Black Swan" events. The term was coined in a 2007 book by essayist and scholar Nassim Nicholas Taleb published right before the financial crisis hit.

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.