Money is pouring in to low-volatility funds

Investors keep waiting for a stock-market downturn.

  • By Gerrard Cowan,
  • The Wall Street Journal
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Low-volatility funds are proving popular as many cautious investors keep preparing for a still-unseen, but long-anticipated, market downturn.

Net inflows this year for the iShares Edge MSCI Min Vol USA ETF (USMV) stood at $5.92 billion through June, according to data from Morningstar Direct—more than 10% of all U.S.-stock ETF inflows for that period, which totaled $53.49 billion. A second ETF devoted to low-volatility stocks, Invesco S&P 500 Low Volatility ETF (SPLV), took in almost $2 billion. Those results ranked the two funds second and eighth among all domestic ETFs at the end of June (the most recent month such aggregate data was available), behind Vanguard S&P 500 ETF (VOO) at No. 1, with $8.33 billion.

The low-volatility funds’ share of the inflow pie was even greater earlier in the year, equaling about half of flows into U.S.-stock ETFs as of May, says Dave Nadig, managing director of ETF.com. Such funds have had to compete with a surge of interest in other parts of the market since then, he says.

Differing approaches

The iShares and Invesco funds take differing approaches, although both have the same fundamental aim: providing exposure to stock sectors with less risk. This means that low-vol funds’ holdings—of financials, consumer staples, utilities and the like—tend to underperform the broader market during boom times, but they generally see less downside when it takes a dip. The $30.6 billion USMV is up nearly 21% so far this year as of the end of July, and so is the $11.8 billion SPLV.

The continued strength of USMV and SPLV at attracting new funds is notable as it comes during a bull run for the S&P 500 (.SPX), says Mr. Nadig. This reflects investor worries for the direction of the market in the coming months, he says.

“I think people are looking at the world, looking at politics, and thinking this seems a little too good to be true,” he says. Other defensive plays, such as fixed income, have also seen interest, he adds, but investors still wish to retain stocks, recognizing that “trying to call the market is generally a bad idea.”

This is where low-volatility equity funds fit in, says Nick Kalivas, senior equity ETF strategist at Invesco. Investors still want exposure to stocks, he says, “but they want to do it in a way where there is a good level of risk mitigation present in their portfolio.” SPLV tends to outperform in periods of uncertainty, he says, though the firm has seen interest in other low-volatility funds, such as Invesco S&P MidCap Low Volatility ETF (XMLV), a $3.1 billion fund that was up 18% so far this year through July.

BlackRock’s (BLK) iShares has seen interest across its range of minimum-volatility funds, says Holly Framsted, head of U.S. iShares factor ETFs at the asset manager. But looking beyond that strong recent demand, Ms. Framsted suggests that minimum volatility isn’t something investors should pursue strictly on a tactical basis but rather is an approach they should always keep in mind.

“Think of it as a form of downside protection to your portfolio over the long term,” Ms. Framsted says. “It’s not necessarily a performance-seeking strategy.”

Considering defensive options outside of minimum volatility, she says investors are increasingly investing in financially healthy, high-quality companies that could outperform their less-efficient peers during a downturn. The iShares Edge MSCI USA Quality Factor ETF (QUAL), which focuses on such stocks, had brought in about $2.25 billion in assets this year by the end of June, making it the seventh-biggest U.S.-stock fund by flows.

Mr. Nadig says investors may want to consider multifactor funds that focus on low volatility and another factor, such as momentum. These types of funds could potentially provide versatility in different market environments, he says.

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