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What a great year 2013 was for the stock market. The S&P 500 closed out the year with 31.8% gain and economic reports signaled that the economic recovery was taking hold. However, as this bull market nears its 5th year, history says we could be experiencing a significant correction sometime in the near future. According to Forbes, the average length of bull markets since 1932 is 3.8 years. Additionally, of the sixteen bull markets since then, only five saw their duration last past 4.5 years. Even so, only three of those five lasted somewhere between 6-9.5 years, which equates to only 20-59 months from now for today's markets. The point here is that this bull is showing its age, and sooner than later, we could experience a long-awaited correction and investors must prepare their portfolios and protect their gains.

Turning to the Vix, an index designed to measure volatility within the S&P 500, is up over 42% year-to-date. Long-term investors who are investing for retirement know that volatility is not a desirable trait for their portfolios. Investors that have retirement in their sights want stable returns and protection from volatility because they will need access to the money soon and do not want to risk big drawdowns in their portfolio. Since March 2009, the Vix Index is down over 60%, highlighting the lack of volatility within the markets. However, as highlighted earlier, it appears 2014 will be the year that volatility resurges back to a more normal state. That being said, Kenneth Green of Edward Jones believes the correction is not here yet, but rather the markets coming back to a state of normality. "The market has a 10 percent correction every three years, and we're overdue".

Source: Google Finance

Long-term investors do have options at their disposal through the use of low-volatility ETFs to help curb volatility risk and maintain exposure, relatively cheaply, to the markets. While there are well over 20 different ETFs that are classified as "volatility" ETFs, I will be covering investments that are well-diversified, reasonable cost, and resemble index funds. These ETFs rely on large caps mostly or stocks that have a low beta (measure of stock's volatility relative to market average). Luckily, there is certainly a wide range of options in the low-volatility ETF department: PowerShares S&P 500 Low Volatility (SPLV), iShares MSCI USA Minimum Volatility (USMV), PowerShares S&P International Developed Low Volatility (IDLV), iShares MSCI All Country World Mini Volatility (ACWV), PowerShares S&P SmallCap Low Volatility (XSLV), PowerShares S&P Emerging Markets Low Volatility (EELV), iShares MSCI EAFE Minimum Volatility (EFAV), and iShares MSCI Emerging Markets Minimum Volatility (EEMV).

As you can see, there is quite a selection of options here. You could build a well-diversified equities portfolio just from low-volatility ETF selection. However, it is important to know about each of these names before investing. Proper research is always an important factor of the investment process.

PowerShares S&P 500 Low Volatility Analysis

Risk: The S&P 500 Low Volatility ETF essentially is designed to be an index fund that carries less volatility than the standard S&P 500 benchmark. SPLV currently yields 2.66% and carries an expense ratio of .25%. While SPLV, much like its peers in the low-volatility ETF offerings, is a new concept and does not carry ratings of metrics such as alpha, beta, standard deviation, r-squared, etc. However, we can speculate that the ETF's alpha will be around 1, beta would be around the low-volatility category average of .93, standard deviation would be less than the S&P 500's 3-year rating of 12.4, and r-squared would be somewhere around the low-volatility category average of 88.

Portfolio Make-up: Turning to SPLV's portfolio make-up, the ETF is made up of giant, large, and medium cap stocks. Giant cap stocks make up 21.1% of portfolio, large cap takes largest exposure with 42.08%, and medium cap takes in 36.82% of the portfolio.

Sector Weights: Looking at the ETF's sector weighting compared to its benchmark S&P 500 shows that the investment has much less exposure to cyclical and sensitive sectors, while having much more exposure to defensive sectors. The ETF's higher exposure to defensive sectors is what makes it a good choice for choppy markets and during uncertainty. That being said, SPLV outweighs its benchmark in basic materials (5.2% compared to 2.7%) and industrials (16.11% compared to benchmark 10.7%), both classified as cyclical and sensitive sectors. Additionally, SPLV is overweight in defensive sectors such as consumer defensive (21.33% compared to 6.14%) and utilities (24.92% compared to 6.04%), but underweight in healthcare (10.67% compared to 13.41%).

Performance: In 2012, SPLV logged a gain of 10.08%, underperforming S&P performance of 16%. In 2013, SPLV saw gains of 23.16% compared to S&P's 32%, and year-to-date we see SPLV down 4% while S&P is down over 5%. As you can see, the ETF has posted nice gains but underperformed its broad index. However, if you remember the beginning of the article, volatility has been down 60% since the start of the bull market. This ETF is a good choice when volatility is a factor in the markets. When we look at year-to-date performance, SPLV has fallen less than its benchmark because volatility is becoming a factor.

iShares USA Minimum Volatility Analysis

Risk: USMV is an alternative to the PowerShares S&P 500 LV ETF. USMV yields 2.24% while costing .15%, both lower than SPLV. Like SPLV, USMV lists the S&P 500 as its benchmark and is still too new to have alpha, beta, standard deviation, and r-squared ratings. However, they are likely to be very similar to SPLV's speculated ratings.

Portfolio Make-up: USMV has its portfolio in 31.21% giant cap, 47.32% large cap, and 21.47% medium cap. As you can see, USMV has a higher portfolio make-up than SPLV in giant and large cap stocks, whereas SPLV has a larger exposure to medium cap stocks. Long-term investors that want even more conservative US stock exposure would likely choose USMV over SPLV for that reason when looking at the capitalization make-up.

Sector Weights: Much like SPLV, USMV is mostly underweight cyclical and sensitive sectors compared to its benchmark, and overweight defensive names. That being said, USMV does outweigh the S&P 500 in basic materials (3.78% compared to 2.7%), consumer cyclical (7.51% compared to 5.89%), communication services (5.22% compared to 2.63%), and industrials (12.49% compared to 10.7%), all of which are listed under cyclical and sensitive sectors. USMV is overweight its benchmark on all three defensive sectors: consumer defensive (17.03% compared to 6.14%), healthcare (18.59% compared to 13.41%), and utilities (8.31% compared to 6.04%).

Performance: In 2012, USMV logged gains of 10.83% and 25.09% in 2012. As we stated above, the benchmark has beaten the ETF but there was extremely low volatility in the markets, so it is hard to say these investments are not worth the trouble. This can be seen with a year-to-date loss of 3% compared to the benchmark's 5% loss for the year so far.

Stay tuned for my next installment in the low-volatility index fund series, where I will introduce investors to low-volatility international ETFs that have the similar traits of well-diversification, reasonable cost, and resemble index funds. While there are many volatility ETF investments to choose from, not all are the same and mistaking the different types of volatility ETFs could be very costly to your portfolio. The idea behind this series is to help long-term investors better understand one method of protecting their portfolios from volatility risk. These new ETFs provide a cost-efficient and diversified method of gaining exposure to the markets in a way that well-manages volatility. Keep in mind that while these ETFs have underperformed the broad market in the past two years, it is hardly useful to judge these names since there was no volatility in the markets. Moving forward, with volatility on the rise, I believe these names could come into play and help investors remain stable in the markets.

Source: Should You Turn To Low-Volatility ETFs During Market Uncertainty? Part 1