The Proper Context Of Low-Beta ETFs

Includes: SPHB, SPLV
by: Roger Nusbaum

IndexUniverse had a post that explored some of the nuances of the PowerShares Low Volatility ETF (NYSEARCA:SPLV) and the PowerShares High Beta ETF (NYSEARCA:SPHB). The article was a little muddled in that it seemed to start out by making the argument for why now might be a good time to buy SPHB but then the author talked about why he does not like the composition of SPHB.

First, to the idea of some sort of tactical strategy of swapping back and forth between the two (this is what I think the first part of the article is about) it is certainly possible, even if not easy to time. Some sort of objective trigger (but probably not a 200 DMA breach) could be used such that you lighten up on volatility after a big move up and you increase volatility after a big drop. It's a lot easier to articulate this than execute it; really not my type of trade.

I would argue that after the great run in the market and for SPHB since October, the time frame chosen in the IU article, we are probably closer to SPLV being the better hold. Since October, per the article, SPHB is up 36%, SPY is up 24% and SPLV is up 15%.

The author brings up the notion of being left behind with SPLV in an up move. That makes sense as typically it is the higher octane names that move up the most in a big lift for the broad market. For people who would rather not try to tactically time swapping low and high beta, the context of how to think about the low beta funds is over the course of the entire market cycle or even longer.

If you've ever read any research on any of the buy/write indexes, these tend to be lower volatility than the broad market, you've seen that the outperformance benefit comes after years of holding it--assuming there will be outperformance. The angle behind these is that historically going up less and going down less has netted out to a better long term result.

Buying a low beta fund but not wanting to trade it tactically requires a willingness to think in terms of years on the belief that up less/down less will continue to net a better long term result. Whether it does or not is a different issue but going in, this should be the mindset.