Low-Volatility ETF Doubles S&P 500 Risk-Adjusted Return

| About: PowerShares S&P (SPLV)
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By John Spence & Tom Lydon

PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV) is billed as a lower-risk equity ETF that offers downside protection, but the fund has actually outperformed the market as it nears its two-year anniversary.

"Interestingly, in nearly every market studied, low-volatility stocks have outperformed high-volatility stocks, a finding at odds with many investors' notions of risk and return," says Morningstar analyst Samuel Lee in a profile of SPLV.

The ETF has sector tilts to defensive industries such as utilities at nearly 31% of the portfolio and consumer staples at about 24%.

Since its May 2011 launch, the low-volatility ETF has gained 30% versus a 21% advance for the S&P 500 over the same period, Bloomberg News reports.

Even more impressively, the $4.1 billion ETF has doubled the risk-adjusted return of the S&P 500 when volatility is factored in. Volatility is the measurement of the tendency of a security to fluctuate in price. So SPLV has outperformed with less bumps along the way.

"The long-term outperformance of low-risk portfolios is perhaps the greatest anomaly in finance," Harvard Business School Professor Malcolm Baker wrote in a 2011 paper in Financial Analysts Journal, Bloomberg notes.

Morningstar's Lee says one reason the strategy outperforms is that high-volatility stocks are systematically overpriced by investors seeking "lottery tickets," or stocks with a small chance of huge upside.

"The evidence behind low-volatility investing is truly impressive. However, low-volatility strategies can underperform during bull markets," the analyst said.

Joel Dickson, a senior investment strategist at Vanguard Group, which doesn't offer low-volatility ETFs, told Bloomberg that these stocks can lag in bull markets such as the 1990s.

"As an investor you have to be willing to stomach periods when this strategy gets killed," Dickson said.

Still, low-volatility ETFs have appealed to investors burned twice in the last 13 years, by the dot-com bust and the 2008 credit crisis.

SPLV holds the 100 stocks from the S&P 500 with the lowest realized volatility over the past year. The ETF allocates more of its portfolio to stocks with lower volatility.

SPLV gained 2.2%, adjusted for price swings, since it was created on May 5, 2011, compared with a 1.1% return for the S&P 500, according to data compiled by Bloomberg.

Other low-volatility ETFs include iShares MSCI USA Minimum Volatility ETF (BATS:USMV), PowerShares S&P International Developed Low Volatility (NYSEARCA:IDLV) and iShares MSCI Emerging Markets Minimum Volatility (BATS:EEMV).

State Street (NYSE:STT) recently launched its first low-volatility ETFs: SPDR Russell 2000 Low Volatility ETF (NYSEARCA:SMLV) and SPDR Russell 1000 Low Volatility ETF (NYSEARCA:LGLV).

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.