ETFs That Lower Volatility And Beat The Market

Includes: EEM, HDV, HILO, SPLV
by: Matthew D. McCall

It is not surprising that investors are starting to think outside the box after such high levels of volatility in the last 12 months. And on top of the volatility is an S&P 500 that is basically unchanged for the year. Why would anyone want to endure such turbulent times to end up where they began?

This is one reason a niche class of ETFs that concentrate on low volatility and high dividends have been greatly outperforming the overall market. It is time to take a look at a few of the ETFs in the sector.

Low Volatility

PowerShares S&P 500 Low Volatility ETF (NYSE:SPLV) – An ETF that is composed of the 100 stocks from the S&P 500 Index that have the lowest realized volatility over the prior 12 months. Because value stocks typically have lower volatility the asset class makes up over three-fourths of the allocation. Large-caps are also dominant in the ETF with about two-thirds in the “big guys."

As far as sectors, the ETF is heavily weighted in utilities (32%), consumer staples (30%) and healthcare (12%). The top two holdings are Southern Company (NYSE:SO) and Procter & Gamble (NYSE:PG). The expense ratio is a low 0.25% and the 30-day SEC yield is an attractive 3.1%.

Since its inception on 5/5/11 the ETF is up 4.5% as the SPDR S&P 500 ETF (NYSEARCA:SPY) has lost 6.6%. An outperformance of 11.1% in such a short period of time is significant and is why investors need to open their eyes to this fairly new product.

High Dividends

The iShares High Dividend Equity Fund (NYSEARCA:HDV) – An ETF that has a different strategy from SPLV, however its allocation and performance has been similar. The process of choosing the stocks that will be in the ETF starts with nearly every publicly traded U.S. stock before the list are broken down to quality income paying stocks. From there the top 75 yielding stocks are chosen to make up the ETF.

The top three sectors are the same as SPLV: Healthcare (27%), consumer goods (22%) and utilities (18%). The top three stocks are AT&T (NYSE:T), Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ). The 75 stocks in the ETF have a P/E ratio of 14.5 and a price-to-book of 3.75. The expense ratio is 0.4% and the 30-day SEC yield is 5.8%. Since 5/5/11 HDV is up 5.3%, beating both SPLV and SPY.

Emerging Markets

Low volatility and emerging markets may sound like an odd couple, but it is possible and the EG Shares Emerging Market High Income Low Beta ETF (NYSEARCA:HILO) brings it to reality. The ETF tracks a dividend yield weighted stock market index that is designed to provide higher yields and lower volatility than the MSCI Emerging Market Index.

The ETF charges a net expense ratio of 0.85% and the current index dividend yield is 6.7%. There are a total of 29 stocks with the largest concentration in South Africa (16%), China (15%), Thailand (14%) and Brazil (12%). Due to the high yields in the sector, telecom stocks make up 27% of the allocation with electricity at 13%.

Since its inception on 8/4/11 the ETF is down 6.3% versus a drop of 12.3% for the iShares MSCI Emerging Markets ETF (NYSE: EEM).

Do Not Chase

Both SPLV and HDV are one day off highs and therefore I would not chase the recent performance. For SPLV there is support in the $25 to $25.50 range and that is where the best buying opportunity will arise. HDV has similar support between $53 and $54. Patience will allow for a better entry point and a better reward-to-risk set-up.

Disclosure: I am long HILO.