Hedging Your Portfolio With Low Volatility ETFs - The COVID Failure
Active trading, CEFs, Portfolio Strategy
Seeking Alpha Analyst Since 2013
I am a retired self-directed investor/trader. In Green's Portfolio, I combine high-yield income investments with swing trading in a Roth IRA account. Until January 2017 I worked 44 years in land use planning and natural resource management in the mid-Atlantic US.
Summary
- Fund managers often choose low and minimum volatility ETFs (low beta) to hedge portfolios against wide price swings of the markets.
- During the spring COVID market selloff, some low beta ETFs apparently failed to function as they were designed.
- I review 5 low and minimum volatility ETFs to demonstrate that investors might just as well avoid these hedging strategies.
I have a friend who was using a professional investment advisor for their retirement portfolio. In the course of time, most of my friends come to know that I have been active in the markets for many years, and so my friend asked if I would review their portfolio and offer my personal thoughts on the advisor's strategy.
My friend's portfolio had a good mix of stocks, bonds, and funds, including some funds described as low or minimum volatility ETFs, presumably designed to hedge against severe swings in price as markets gyrate. These "low beta" funds seem to pay a low-to-moderate yield, typically about 2-4% distribution, which is higher than the S&P 500 (currently 1.57% for the SPY) but far lower than the Closed-end funds I favor and that typically pay upward of 7%. This is to say nothing of my habit of swing or position trading my investments to capture even higher returns.
The structure of these low vol funds differs for sure, but most seem to involve a selected set of stocks whose prices are supposed to move less than average market moves. They are also reasonably diversified, with stocks across cyclical, defensive, and sensitive sectors.
Investing styles and strategies differ. In searching for a reason for including these low beta holdings in a portfolio, it seems that these are more suited for buy and hold investors. I like to get paid early and often because the markets giveth and they taketh away. So I could conclude that whereas low beta is a price and yield flattening strategy for risk management, swing trading is a time strategy for risk management.
I told my friend that in my view they were sacrificing higher yield for some cushion or safety against large drawdowns in price when the markets get crazy.
Then COVID hit and the markets took a deep dive starting in late February and lasting about a month. The SPY pulled back -35.6% and has recently, finally, recouped the correction. Happy news! Except for those holding some of these low beta products!
My friend's portfolio included a fairly large percentage of the overall portfolio in 5 low vol ETFs selected by their investment advisor. These were:
- Invesco S&P 500 Low Volatility ETF (SPLV)
- Invesco S&P 500 Small Cap Low Volatility ETF (XSLV)
- Invesco S&P 500 Mid Cap Low Volatility ETF (XMLV)
- iShares MSCI USA Minimum Volatility Factor ETF (USMV)
- iShares MSCI EAFE Minimum Volatility Factor ETF (EFAV)
I was curious about how well these 5 funds actually served as a hedge against the COVID market selloff, and I was surprised to see that overall they sold off every bit as much as the SPY, with EFAV only slightly less volatile as the SPY, USMV about even with the SPY, and the other three more volatile than the SPY. Here are the percentages of pullback for these 5 funds from their February highs to their March lows:
- SPLV -37.9%
- XSLV -46.9%
- XMLV -42.6%
- USMV -34.4%
- EFAV -29.1%
In addition, none of these 5 funds has yet reached highs greater than the levels in February before the COVID selloff. I'd throw up some charts, but it's honestly not worth it. I'll just note that XMLV and XSLV are lagging the SPY's post-March recovery significantly, with the latter still below the 50% Fibonacci retrace.
I wondered if these funds failed to perform adequately as a hedge for other selloffs less severe than the COVID event. But that didn't seem to matter in that if they failed to work well during a once-in-a-decade event, who cares about hedging minor pullbacks? I think likewise if I were to ask why they failed during COVID - what was so special about that event? It doesn't matter.
I admit that I didn't review any low vol ETFs other than these 5, but as they were part of an overall portfolio strategy selected by a professional investment advisor, I am assuming that they are representative of these products.
My conclusion is that I don't really see any reason to hold these products in a portfolio. Considering price movement (pullback and rebound) and yield, they seem to underperform. Selecting many stocks and funds with higher yield (caution, not yield traps!) and buying them on sale should generate higher total returns within a reasonable time than low vol ETFs such as the 5 discussed here. I wonder how fund managers think about what happened during the COVID selloff with these products and whether they are still inclined to recommend them.
I hope that this missive was of interest or value to you. If so, please share with a friend or another who might be interested. If you've had a different experience or think that I've missed something important here, please feel free to bring that to my/our attention. I'd like to do some more of these short blogs as things keep coming my way, if these are of interest.
Best to your investing/trading!
=Green=
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