The global economy is slowing. U.S. hiring and wage gains are cooling. Trade tensions with China and Mexico are dragging on. It’s anyone’s guess if the Federal Reserve will cut interest rates. The news has made for a choppy market.
With all this uncertainty, investors who want to take some risk off the table and become a bit more defensive should look for lower-volatility exchange-traded funds with holdings that provide dividends. The income component helps the fund hold up better during market volatility, and these ETFs are more heavily weighted to defensive stocks such as consumer staples, utilities, and real estate.
Investors should aim for “minimum volatility, greater diversification and keeping an eye on asset allocation,’’ to reduce risk, says Alex Pire, head of client portfolio management at Seeyond, a unit of Natixis Investment Managers.
Investors were rattled by May’s stock market rout. In one week alone—May 23 through May 29—investors yanked $993 million out of all types of ETFs, according to Investment Company Institute estimates. (Final numbers will be available at the end of June.) That’s the biggest single-month amount of outflows since at least early 2014, according to ETF.com, breaking a three-month streak of inflows.
Then there’s unusual activity in the bond market: With 10-year Treasuries yielding less than the three-year note—creating an inverted yield curve that many see as a sign of a pending recession—the bond market has been looking for the Fed to cut rates. Fed officials last week signaled that rates could come down to keep the economy on solid ground. The Fed’s target policy rate is in a historically low range of 2.25% to 2.5%. If rates go lower, yield will be even harder to find.
So how to play it safer? Low volatility and high dividends: The iShares Core High Dividend ETF (HDV) and Vanguard High Dividend Yield ETF (VYM) are diversified across sectors, with companies that have a history of raising dividends, including Exxon Mobil (XOM) and Procter & Gamble (PG), says Todd Rosenbluth, head of ETF and mutual fund research at CFRA. Both are cheap, charging fees of less than 0.1%.
The FlexShares Quality Dividend Defense Index ETF (QDEF) “combines a historical dividend component and companies with financial stability to maintain the dividend,” Rosenbluth says. The fund includes Johnson & Johnson (JNJ), Microsoft (MSFT), and Exxon Mobil.
The Invesco S&P 500 Low Volatility ETF (SPLV) holds 100 of the least risky stocks in the index, and it rebalances on a quarterly basis in order to add companies with more recent lower volatility, he says.
The iShares Edge MSCI Min Vol USA ETF (USMV) holds the least-volatile U.S. stocks, leaning to consumer defensive stocks, utilities, and REITs, says Alex Bryan, Morningstar’s director of passive strategies research. This ETF, he notes, “loses less in a market downturn” and provides 20% to 30% lower volatility than the market, “These are the types of funds you can hold through thick and thin.” The iShares Edge MSCI Min Vol EAFE ETF (EFAV) is the global version of the U.S. fund, investing in equities of developed markets outside the U.S. and Canada; it holds higher-quality defensive companies such as Nestlé (NSRGY) and Unilever (UN).
You may have a more restful night, but there’s a downside to focusing on risk aversion. These ETFs “should underperform in up markets,” Rosenbluth says. “You won’t fully benefit if the market rallies back.”
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