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Correcting Low Volatility Misconceptions

|Includes: DVY, SPHD, iShares Edge MSCI Minimum Volatility USA ETF (USMV)

In a recent article, John Mauldin has made several claims about low volatility that I believe are incorrect.

(1) "Let's just say there is a positive relationship between risk and reward, which should be obvious to everyone here."

Although I agree that there is generally a positive relationship between risk and reward, this relationship can break down when risk is too high (otherwise why would it be risky?). With the market in general, the relationship also fails during downturns in the market, and this results in the outperformance of low volatility over time, as I have shown in my recent article.

(2) "It isn't strictly low-volatility stocks that people buy, though. It's also high-dividend payers (which are essentially the same thing)."

Low volatility and high dividend payers are not the same thing at all. According to Morningstar, the 12-month yield of the iShares Edge MSCI Min Vol USA ETF (BATS:USMV) is 1.97%, whereas the 12-month yield of the S&P 500 (NYSEARCA:SPY) is 2.06%. If you want to see what low volatility and high dividends look like when combined, look at the PowerShares S&P 500® High Div Low Vol ETF (NYSE:SPHD) with a 12-month yield of 3.41%.

(3) "Here's a chart of the iShares Select Dividend ETF (NYSEARCA:DVY). It looks the same as the iShares Edge MSCI Min Vol USA ETF USMV."

That is only because the two funds are not plotted on the same chart. In 2015, according to Morningstar, the USMV total return was 5.45%, whereas the total return for DVY was -2.07%. That is a fairly substantial difference to me.

(4) "It could take a small crisis or correction to turn low-volatility stocks into high-volatility stocks."

If that happens, investors in low volatility stocks (or funds) will no longer be invested in those stocks. That's the whole point of investing in low volatility; you don't invest in high-volatility stocks. This means that portfolio composition is dynamic; you are not stuck with investing in stocks that were low volatility 5 years ago.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.