One of the most noteworthy innovations in the ETF industry over the last several years has been the development of funds that deliver targeted exposure to investment “factors”, allowing for easy access to techniques that previously required extensive research and maintenance. From high momentum to low beta, there are now ETFs that slice and dice broad equity indexes in a number of different ways to deliver unique risk/return profiles.
ETFs focusing on low volatility stocks have become immediately popular with investors; eight such products have debuted over the last year, and they have already accumulated close to $1 billion in assets. The PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV), which targets the 100 components of the S&P 500 with lowest historical volatility, has gathered about $880 million since debuting last May. Other ETFs exist targeting low volatility stocks in emerging markets (NYSEARCA:EEMV), developed markets outside the U.S. (EFAV, XLVO), and small cap domestic equities (NYSEARCA:SLYV) [see also Inverse VIX ETN (NASDAQ:XIV) Gets Hot Again].
The appeal of these products is easy to understand; achieving exposure to stocks that have historically exhibited low volatility relative to their peer group should smooth the ups and downs of an overall portfolio. That would have the effect of limiting downside losses, while still allowing for investors to maintain their equity exposure. Low volatility ETFs essentially allow investors to scale back some of their risk exposure while still maintaining an equity allocation that includes significant upside potential. For investors with some mild anxiety about the economic outlook, shifting exposure to low volatility stocks can be a way to take some chips off the table without risking the possibility of missing out entirely on a big rally in prices. There is also some evidence to support the notion that low volatility strategies may be effective over the long run, thanks to the ability to limit losses during downturns [see also Volatility ETPs: Where Are The Critics Now?].
High Volatility ETFs: Worth A Closer Look?
In addition to funds targeting low volatility stocks, the ETF lineup now includes products targeting high volatility equities–securities that have historically exhibited greater volatility than their peer group. These ETFs haven’t received nearly the attention from investors that their low volatility counterparts have, perhaps as a result of the uncertain economic environment. But with optimistic signs coming from the U.S. economy and perhaps indications that Europe is regaining its footing as well, these products could be positioned to outperform broad markets in 2012. Volatility is a two-sided coin; in bear markets, volatile stocks often experience big declines. But when stocks are climbing higher, exposure to high volatility stocks can translate into additional gains:
Russell 1000 High Volatility ETF (NYSEARCA:HVOL): This ETF is linked to an index that consists of up to 200 components of the Russell 1000 that have exhibited the greatest variability in total returns over the last 60 days. Perhaps not surprisingly, HVOL features a tilt towards the financial sector: JPMorgan, Wells Fargo, and Bank of New York Mellon are all among the ten largest individual holdings, and that industry makes up about a quarter of the total portfolio. At the other end of the spectrum are sectors that are known for stability; allocations to utilities, telecom, and consumer staples are minimal.
Russell 2000 High Volatility ETF (SHVY): This ETF is the small cap counterpart to HVOL; the methodology is similar, with stocks selected from the universe of U.S. small caps. SHVY’s sector allocation, however, is slightly different. The biggest weights in this ETF go to technology (21%), industrials (17%), and consumer discretionaries (14%). SHVY has almost 400 individual holdings in total, led by Qlik Technologies and Sterling Financial.
High Beta ETFs
In addition to the two high volatility ETFs highlighted above, there are also a number of ETFs that target high beta stocks. While beta and volatility are obviously different metrics, there are some very strong similarities in these approaches; higher beta generally means greater sensitivity to broad movements in equity markets, meaning that the ETFs below can be expected to include a significant shift towards volatile stocks:
- PowerShares S&P 500 High Beta Portfolio (NYSEARCA:SPHB): This ETF focuses on the high beta stocks in the S&P 500. SPHB currently has about 95 individual holdings, including a major allocation (more than a third of the total portfolio) to financials. SPHB has minimal exposure to telecom, consumer staples, and utilities.
- Russell 1000 High Beta ETF (NYSEARCA:HBTA): This Russell ETF targets high beta stocks from the Russell 1000, but features a much smaller allocation to financials. Industrials (35%) and energy (17%) make up big slugs of HBTA, with meager allocations to utilities, consumer defensive, and health care stocks.
- Russell 2000 High Beta ETF (NYSEARCA:SHBT): This ETF targets high beta stocks in the small cap universe; SHBT consists of about 225 stocks, with a tilt towards industrials, technology, and energy.
Disclosure: No positions at time of writing.
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