Low-Volatility ETFs To Protect Against Market Gyrations

by: Tom Lydon

After the wild market oscillations in 2011, many investors have become guarded in their equities allocations. Meanwhile, exchange traded funds that track the "low volatility" theme have made their way into the markets, providing investors a more cautious position to global stocks.

Minimum or low volatility ETFs specifically select equity securities from an underlying benchmark that exhibit lower absolute volatility, essentially producing a more stable performance.

"Researchers have come up with several explanations as to why low-volatility stocks post such great risk-adjusted performances," Morningstar analyst Samuel Lee said in a research note. "The most convincing involves leverage aversion. Investors who target above-market returns may be unwilling or unable to use leverage to reach their expected-return targets. By resorting to volatile stocks (more accurately high-beta stocks), which theoretically should outperform less-volatile stocks, they hope to earn above-average profits."

For example, the iShares MSCI Emerging Markets Minimum Volatility Index Fund (BATS:EEMV) picks stable stocks from the MSCI Emerging Markets Index. EEMV is up 13.0% year-to-date, whereas the Index is up 11.9%. However, Lee notes that this outperformance won't last since the fund's strategy will underperform during bull markets.

"EEMV's beta, or sensitivity to the market's gyrations, is about 0.80, meaning for each 1% move in the MSCI Emerging Markets Index, EEMV will move in the same direction by 0.8%," Lee added.

PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSE:EELV) is up about 9.4% since its January launch. EELV has a beta of 0.7.

Brendan Conway for Barron's also points out other global low-volatility ETF options, including the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA:ACWV), which is up 6.8% year-to-date and has a 0.65 beta; the Russell Developed ex-U.S. Low Volatility ETF (XLVO), which is up 6.3% year-to-date; and the Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT), which is roughly unchanged since its January inception.

The largest ETF in the low volatility category is the PowerShares S&P 500 Low Volatility Portfolio (NYSE:SPLV), with $1.54 billion in assets. It tracks 100 of the S&P 500's stocks that have shown the lowest volatility over the last year. The fund is up 5.1% year-to-date, compared to the SPDR S&P 500 (NYSEARCA:SPY) gain of 11.8% year-to-date. SPLV has a beta of 0.7.

Axioma, a risk-modeling firm behind the Russell 1000 Low Volatility ETF (NYSEArca: LVOL), argues that their product provides a more diversified market exposure and higher value for investors.

These types of investments appeal to investors as a long-term, buy-and-hold investment.

"Over the past 50 years, the least-volatile stocks have performed about as well as the market, but with far less risk," Lee said.

Max Chen contributed to this article.

Disclosure: I am long SPY.

Additional disclosure: Tom Lydon's clients own SPY.