Volatility has made its way back into the markets. And unsurprisingly, so has curiosity about a special brand of exchange-traded fund: low-volatility ETFs.
The desire to tamp down volatility is pretty easy to understand: Investors hate uncertainty, and they hate to lose money. One of the easiest ways to do both is to "go to cash" by selling off equities. But naturally, if you panic-sell, you risk throwing the baby out with the bathwater. And in many cases, investors who jettison their stocks en masse on the way down cement their losses while leaving themselves out of the recovery.
Enter low-volatility ETFs.
In a variety of ways, these funds try to reduce overall volatility (and downside) while still keeping you invested in the equity market, so you can still capture some upside whenever the markets return to a calmer, more productive trajectory.
But here's an important lesson that investors learned the hard way during COVID: Low-vol ETFs aren't magic bullets against rapid downside events. These funds typically can reduce overall volatility over longer time periods, but they still can suffer mightily against sudden market shocks. So, for instance, if you're looking to ward off a potential market contagion event from China's recent Evergrande debacle, check what's inside – the simple fact that they're meant to reduce volatility doesn't mean they're immune.
Here are 11 low-volatility ETFs that should give you more peace of mind in the long run. While all 11 funds should help investors reduce volatility, they do so across a number of strategies – not just low-vol, but also min-vol, "buffering" and other approaches. Take a look.
Data is as of Sept. 19. Dividend yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Invesco S&P 500 Low Volatility ETF
- Assets under management: $7.9 billion
- Dividend yield: 1.5%
- Expenses: 0.25%
When it comes to volatility products, you typically see two types: low-volatility ETFs and minimum-volatility ETFs. Let's start with the former.
The Invesco S&P 500 Low Volatility ETF (SPLV) is a pretty straightforward fund that tracks the S&P 500 Low Volatility Index, which is composed of the 100 S&P 500 components with the lowest realized volatility over the past 12 months. It then assigns weights to each stock based on its volatility (well, lack thereof).
One popular way to measure volatility is called "beta," which tracks a security's volatility compared to some benchmark. The benchmark here is the S&P 500 (.SPX), and the benchmark will always have a beta of 1. SPLV has a beta of 0.70, which implies the fund is about 30% less volatile than the broader market.
Again, this doesn't mean SPLV will outperform during a market shock. During the quick COVID bear market, this low-volatility ETF underperformed the S&P 500 by about 2 percentage points in in that time. It has done better over longer periods of tumult, however. Take June 2015 to June 2016, when the market's roller-coaster movement generated a marginally negative return; SPLV was up by nearly 9%.
The portfolio is bound to change over time depending on which parts of the market are more volatile than others, but for now, it's unsurprisingly heavy in consumer staples (22.3%) and utility stocks (18.2%) – two defensive, high-yielding sectors. Top individual holdings include telecom Verizon (VZ), consumer products brand Procter & Gamble (PG) and fast-food giant McDonald's (MCD).
iShares Edge MSCI Min Vol USA ETF
- Assets under management: $28.0 billion
- Dividend yield: 1.4%
- Expenses: 0.15%
Minimum-volatility ETFs work a little differently.
Rather than simply taking a portfolio of the lowest-volatility stocks within an index, min-vol funds evaluate not just volatility, but other metrics too, such as correlation (how a security moves in relation to the market). They also sometimes try to keep sector weightings and other factors close to the original index they're working with. The idea is to put together a portfolio that minimizes risk while still achieving some other goal. But because of that, min-vol ETFs sometimes will hold stocks with relatively high volatility (such as gold miners).
If it's hard to tell the difference, think about it this way: Min-vol ETFs try to provide a low-volatility basket of holdings. Low-vol ETFs try to provide a basket of low-volatility holdings.
That brings us to the iShares Edge MSCI Min Vol USA ETF (USMV).
USMV applies a multi-factor risk model, which examines traits such as value and momentum, to the MSCI USA Index, which includes large- and mid-cap stocks. But it also applies a maximum cap weight for every stock (2%, or 20x the stock's weight in the S&P 500, whichever is lower), and its sector weight must be within 5% of the benchmark's standard weight. The goal is to build a portfolio that's less volatile than the broader market – just not by selecting the absolutely least volatile stocks to do it.
The result? Some of what you'd expect, and some of what you might not. Healthcare (19.0%) and consumer staples (10.3%) are two of the heaviest-weighted sectors. But tops is information technology, at a full quarter of USMV's assets. What gives? Well, among other things, remember that over the past couple of years, mega-cap tech has been increasingly viewed as a relative "safety" play given their wide moats and ample cash.
Communication stocks – which include slower-moving dividend payers such as Verizon and AT&T (T), but also growthier stocks like Alphabet (GOOGL) and Activision Blizzard (ATVI) – comprise another 10.3%.
USMV, like SPLV, has a fairly low beta, at 0.75.
Fidelity Low Volatility Factor ETF
- Assets under management: $476.1 million
- Dividend yield: 1.2%
- Expenses: 0.29%
The Fidelity Low Volatility Factor ETF (FDLO) culls its picks from a universe of the 1,000 largest U.S. stocks based on market cap, which again ends up resulting in some mid-cap holdings.
Fidelity tries to select the least volatile companies by considering three factors equally:
- Five-year standard deviation of price returns: Measures long-term price volatility, favors stocks with lower standard deviations
- Five-year beta: Measures stock sensitivity to market movements, favors stocks with lower beta
- Five-year standard deviation of EPS (earnings per share): Measures volatility of corporate profits, favors stocks with lower standard deviations of profits
Here again, you get some real head-scratchers that smack in the face of convention. Technology – anchored by Microsoft (MSFT) and Intel (INTC) – is an outsized 27.7% of assets. Financials and communication stocks each make up roughly 11%. But the traditionally "defensive" consumer staples sector is just 5% of the portfolio, utilities are just 2%. Other low-volatility ETFs tend to treasure these sectors.
FDLO does consider market capitalization when weighting the stocks (larger companies make up a bigger part of the fund), but it also uses an "overweight adjustment" to keep any one company from having too large an influence on the fund. For example, $2.2 trillion Microsoft makes up 6.3% of the fund, while $220 billion Accenture (ACN) comprises 1.6%. Thus, Microsoft is 10 times bigger than Mastercard (MA), but accounts for just four times the AUM.
Invesco S&P MidCap Low Volatility ETF
- Assets under management: $1.4 billion
- Dividend yield: 1.0%
- Expenses: 0.25%
Several of the market's hottest growth stocks over the past few years have been mid-cap stocks – between $2 billion and $10 billion – at some point. But collectively speaking, mid-caps don't get nearly the attention their smaller and larger brethren do.
That's too bad. Because mid-cap stocks tend to outperform both over time, and that outperformance looks even sweeter when you consider their risk relative to large and small companies.
Low-volatility ETFs such as the Invesco S&P MidCap Low Volatility ETF (XMLV) reduce your risk in mid-caps in two additional ways: by spreading it across dozens of stocks, and by focusing on low volatility. Specifically, XMLV holds the 81 lowest-volatility stocks in the S&P MidCap 400 Index.
XMLV stands apart from the aforementioned low-volatility ETFs in that its top sector holdings are industrials (21.5%) and real estate (18.6%). It also has a 11% and 10% weights in materials and financials, respectively. The only traditionally defensive sector with double-digit weight is healthcare, at roughly 15% of assets. Interestingly, there is zero energy exposure.
Legg Mason Low Volatility High Dividend ETF
- Assets under management: $734.1 million
- Dividend yield: 2.8%
- Expenses: 0.27%
Some low-volatility ETFs throw in other small tweaks. For instance, the Legg Mason Low Volatility High Dividend ETF (LVHD) is one of a handful of low-vol funds that are looking for stable stocks, but within a universe of high-yielding dividend payers.
Low volatility swings both ways, after all. Sometimes it's advantageous to own stocks that are more volatile than the market – if, say, the market is heading higher, but your stocks are ascending even more rapidly. By the same token, reducing volatility can limit your upside. But you can make up some of the difference if you're also drawing returns in the form of largest dividends.
LVHD starts with a universe of equities that's considerably larger than most of these other funds; at 3,000 U.S. stocks, the list inevitably includes mid- and even small-sized companies. It then narrows the list down to profitable companies that can pay "relatively high sustainable dividend yields." It then looks for price and earnings volatility – the lower those metrics are, the better the score, and thus their weight in the fund.
Legg Mason's fund rebalances quarterly, and when it does, no stock can account for more than 2.5% of assets. Sectors are capped at 25%, though REITs are limited to 15%.
This ETF typically holds between 50 and 100 stocks, with the number at 87 currently. And defensive, dividend-paying sectors are just as influential as you'd imagine they would be: Consumer staples is tops at 28.2%, followed by utilities (15.9%), real estate (12.2%) and healthcare (10.2%). Industrials are the only other double-digit exposure, at 14.8%. No wonder, then, that LVHD yields nearly 3% while the S&P 500 yields 1.3%.
Top 10 holdings currently include power management company Eaton (ETN), Big Pharma firm Pfizer (PFE) and tech mega-cap Cisco Systems (CSCO).
Invesco S&P International Developed Low Volatility ETF
- Assets under management: $714.7 million
- Dividend yield: 2.2%
- Expenses: 0.25%
Investors typically like to have at least some exposure to international stocks to help hedge against any downturns in U.S. equities. But plain-Jane international exposure doesn't do much to defray the risk when markets all over the world are shaking.
The Invesco S&P International Developed Low Volatility ETF (IDLV) is a way to remain invested overseas while trying to reduce some of the volatility that Japan, Western Europe and other developed regions of the world are experiencing.
It's not a bad way to collect yield, either.
The IDLV tracks the S&P BMI International Developed Low Volatility Index, which is made up of roughly 200 constituents across several developed-market nations. It then assigns weights to the stocks based on their realized volatility over the trailing 12 months – again, the lower the volatility, the higher the weight.
At present, IDLV is invested in stocks from 10 developed nations. Canada (18.2%) and Japan (16.0%) make up the largest concentrations, with Singapore comprising another 8.0% of assets. Consumer staples (16.8%) and utilities (14.8%) are well-represented, but the highest allocation of assets goes to financials, at 22.3%. That's largely because of heavy weights to several Canadian bank stocks, including Canadian Imperial Bank of Commerce (CM) and Royal Bank of Canada (RY).
The other bonus? International large-cap stocks tend to yield more than their American counterparts, and as a result, this collection of low-vol plays yields a decent 2.2% right now.
iShares Edge MSCI Min Vol Emerging Markets ETF
- Assets under management: $3.8 billion
- Dividend yield: 2.3%
- Expenses: 0.25%*
You can also use low-volatility ETFs to get calmer results out of more volatile areas of the market.
The iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV) holds a little more than 300 stocks domiciled in "emerging" or "developing" countries. Countries such as the U.S., Japan and Canada are considered "developed" – they have established, relatively stable markets, with not a lot of geopolitical risk, but also, growth tends to be less robust in these kinds of nations. Emerging markets, on the other hand, typically feature better growth profiles, but less reliable markets thanks to risks such as volatile country leadership, risk of corruption and fewer stock-market regulations.
This iShares ETF is one of a few ways that less risk-averse investors can still get exposure to the high growth of emerging markets. EEMV spreads your risk across hundreds of holdings, and across a dozen countries, selecting picks based on their low-volatility characteristics. Better still, single-stock risk is minimized, with no individual company holding more than a 1.7% weight.
But buyer beware. Like most emerging-market funds, EEMV is heavily invested in China (28.0%), which is naturally problematic given that's the epicenter of the current volatility risk (Evergrande). Taiwan is another 17.1%, and India is 15.6%. Still, the EEMV held up better than its traditional counterpart, the iShares MSCI Emerging Markets ETF (EEM), by about 6 percentage points in the downturn. so far through the coronavirus-inspired downturn.
Perhaps more encouragingly, it has outperformed EEM by more than 2 percentage points on a total-return basis since the fund launched in October 2011.
* Includes a 45-basis-point fee waiver.
First Trust Dorsey Wright Momentum & Low Volatility ETF
- Assets under management: $127.3 million
- Dividend yield: 0.2%
- Expenses: 0.60%
The First Trust Dorsey Wright Momentum & Low Volatility ETF (DVOL) is a mouthful, and it might sound like a paradox at first. However, it's an interesting fund that holds up well during down markets but also is plenty competitive when stocks begin to heat up again.
Its methodology is a little complicated, to be fair.
Every quarter, the index starts with the constituents of the Nasdaq US Large Mid Cap Index (large- and mid-cap stocks) that meet certain basic eligibility criteria such as a minimum average daily dollar volume of $1 million for the previous 30 days. It then looks for stocks that have strong price momentum compared to the broader market, then selects the 50 least-volatile stocks from the trailing 12 months. Stocks with the lowest volatility make up the fund's largest weights.
More succinctly, DVOL is taking a momentum strategy – essentially buying stocks that are performing relatively well – and pairing it with low volatility.
DVOL has a 29.2% weight in the industrial sector, and another 21.2% in financials. Consumer discretionaries are another large chunk, at 15.1%. Two sectors – energy and, quite notably, utilities – aren't represented at all.
This strategy has led to mixed results. For instance, it outperformed the market during the Q4 2018 drop, as well as through this volatile 2021 summer. However, like many other low-volatility ETFs, DVOL actually underperformed the S&P 500 by a couple percentage points.
JPMorgan Ultra-Short Income ETF
- Assets under management: $18.3 billion
- SEC yield: 0.3%*
- Expenses: 0.18%
While low-volatility bond ETFs do indeed exist, you can do well for yourself with a much more straightforward fixed-income tactic: holding ultra-short-term debt.
The JPMorgan Ultra-Short Income ETF (JPST) doesn't follow a low-volatility index, a minimum-volatility index, a minimum-variance index or any of that. It simply holds roughly 720 bonds with an average duration of less than one year. Currently, the fund would be expected to decline a mere 0.7% for every 1-percentage-point hike in interest rates.
JPST's holdings are extremely low-risk. The average effective maturity of the bonds it holds is a little over a year. All of them are investment-grade, and about 70% of them receive A ratings or higher. That said, nearly two-thirds of the bonds are corporates, rather than even safer Treasuries and other agency debt, so it's still able to pay out a yield of 0.3%. That won't make you rich, but it's better than the lower and even negative SEC yields offered up by ultra-short Treasury funds.
This fund is effectively planted in the ground, for better or worse. Since inception in May 2017, the difference between its lowest low and highest high is roughly 4%. Compare that to the 14% maximum difference in the iShares Core U.S. Aggregate Bond ETF (AGG), which tracks the effective benchmark for bond funds.
That makes JPST a solid place to park some funds until the world looks a little safer.
* SEC yields reflect the interest earned after deducting fund expenses for the most recent 30-day period and are a standard measure for bond and preferred-stock funds.
Amplify BlackSwan Growth & Treasury Core ETF
- Market value: $879.7 million
- Dividend yield: 0.1%
- Expenses: 0.49%
If you really do want to stave off a portfolio apocalypse, buffered ETFs might be more your speed.
Unlike regular low-volatility ETFs that typically invest in, say, all equities or all bonds, buffered ETFs typically will invest part of their portfolio in certain options contracts that allow the fund to guarantee some level of maximum loss, be it 5%, 10%, 15% or more.
The Amplify BlackSwan Growth & Treasury Core ETF (SWAN) is perhaps the best-known of these buffered ETFs. This is a very new class of funds that has only been around for a few years. The first buffered funds came to life in August 2018, and SWAN went live in November of that year. The category has caught on, spawning several dozen ETFs to date.
How SWAN generates this kind of exposure is by investing roughly 90% of assets into U.S. Treasuries, while investing 10% in long-term equity anticipation (LEAP) call options on the SPDR S&P 500 ETF Trust (SPY).
Because of the leveraged nature of options, that "mere" 10% investment provides much more equity exposure than it would seem. Regardless, there's still a performance tradeoff. SWAN was rightfully the belle of the COVID bear-market ball, declining a mere 8% when the S&P 500 was cut down by more than a third – it clearly has been able to achieve its goal of limiting severe losses. It keeps volatility super-low, too, with a beta of a mere 0.36.
But since the March 23 bottom, Amplify's ETF has delivered a 29% total return (price plus dividends) while the index has more than doubled. It's not nothing, but SWAN clearly shines brightest when the stock market is on the ropes.
Innovator U.S. Equity Power Buffer ETF September
- Assets under management: $264.5 million
- Dividend yield: 0.0%
- Expenses: 0.79%
Innovator U.S. Equity Power Buffer ETF September (PSEP) comes from one of the largest providers of buffered ETFs. And you'll note that unlike SWAN, PSEP's name includes a specific month.
Many buffered ETFs will protect you against some predetermined amount of downside over a certain time period, usually 12 months. So in this instance, the Innovator U.S. Equity Power Buffer ETF September will protect investors against the first 15% of S&P 500 losses for the 12-month period starting Sept. 1, 2021.
However, it also demonstrates why many of these funds also are called "defined-outcome" funds. In addition to telling investors how much protection they can expect, buffered-ETF providers can also tell you the extent to which your upside will be capped. In the case of PSEP, the maximum potential return (before fees) investors can expect is 8.5% over the next year.
In a way, that makes the decision of whether to invest in one of these funds fairly straightforward: If you believe firmly that the S&P 500 will struggle over the next year, you can avoid a decent chunk of losses while still participating in modest upside.
But there is a catch: All caps and downside guarantees exist within the 12-month period. For instance, if you purchase a September fund midway through the month, and the S&P 500 has already lost some ground, you're effectively losing out on some of that downside protection. So if you want the full "benefits" of these funds, it makes sense to invest at the very beginning of the month – in late September, investors might want to eyeball the start of the October series' next 12-month period.
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