Low Volatility Continues To Gain Steam

by: David Fabian

Last month PowerShares announced that they would be expanding their suite of low volatility exchange-traded funds with two additional offerings. These strategies include:

  • PowerShares S&P Mid-Cap Low Volatility Portfolio (NYSEARCA:XMLV)
  • PowerShares S&P Small-Cap Low Volatility Portfolio (NYSEARCA:XSLV)

I have been a big fan of low volatility ETFs for some time now since the initial launch of the PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV) back in 2011. The basis behind the strategy for these funds is to take the underlying S&P indexes and identify a subset of stocks (typically 80-120) that have the lowest price volatility for the last quarter. What you are left with is a unique portfolio of equities that typically have very steady returns and smaller price fluctuations.

Low volatility doesn't sound exciting, but in 2012 the total return of SPLV was +10.10% (with dividends reinvested) as compared to +15.99% for the SPDR S&P 500 (NYSEARCA:SPY) over the same time period. The difference between the two is that the price trends in SPLV tended to be much smoother and more consistent. In addition, SPLV pays a healthy monthly dividend that would make any income investor drool.

Generally you will see these low volatility funds decline less than their fully loaded index peers during periods of price decline. For trend followers and active managers these funds may give us the ability to stay invested during periods of short-term market corrections instead of getting stopped out of a position and getting whipsawed.

Typically the make-up of low volatility funds are focused in the areas of consumer staples, utilities, and health care sectors. However, in XMLV and XSLV there is also a healthy dose of financial stocks as well. This is primarily attributed to their holdings in smaller regional banking and financial institutions.

I believe that all three of these funds make an excellent addition to any portfolio as a core holding that can represent small, mid, or large-cap stocks in a diversified investment vehicle.

The Other Side of the Coin

The one drawback to low-volatility ETFs is that they aren't expected to rise as quickly in strong market up-trends. Investors that are seeking higher volatility funds might consider the PowerShares S&P 500 High Beta Portfolio (NYSEARCA:SPHB). The stocks in SPHB will have a higher sensitivity to market price movements which may prove advantageous under certain circumstances.

In 2012 for instance the total return of SPHB was +18.20% as compared to the aforementioned +15.99% return of SPY. The sectors that are most prevalent in SPHB include financials, energy, and technology. In addition they are generally more heavily traded companies that are in the news more frequently.

Whether your tastes run towards more conservative or aggressive, the ETF industry is continuing to innovate and give investors unique choices when it comes to the management of their accounts.

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.