Investors hunting for protection after last year’s market turbulence are snapping up so-called smart funds in the hopes of sidestepping the next downturn.
The S&P 500 (.SPX) has advanced 11% so far this year, but that hasn’t stopped investors from looking for a safer way to bet on stocks. Two of the biggest exchange-traded funds that try to pick less volatile companies have been among the most popular so far this year. A surge of new money has pushed assets in both the iShares Edge MSCI Min Vol USA ETF (USMV) and the Invesco S&P 500 Low Volatility ETF (SPLV) to records.
In all, ETFs that try to pick less risky stocks have taken in $11 billion since the beginning of November, according to Morningstar. The funds, billed as “smart beta” or “strategic beta,” are pegged to bespoke indexes that target stocks that are less susceptible to violent price swings.
ETF issuers have been trying for years to get cost-conscious investors to embrace more sophisticated—and pricier—styles of index investing. Last year’s rocky markets did what slick marketing and backtests failed to do: provided a real-world example of how such funds can outperform when markets are topsy-turvy.
“You still need exposure to stocks, but you may want to do it a little more defensively,” said Larry Carroll, chief executive of Carroll Financial, an investment-advisory firm in Charlotte, N.C., that manages about $3 billion.
Mr. Carroll’s choice is the iShares Edge MSCI Min Vol USA ETF, which he said accounts for 5% to 10% of his clients’ stock portfolios. Its three biggest holdings are Newmont Mining Corp. (NEM), Waste Management Inc. (WM) and Visa Inc. (V), compared with Microsoft Corp. (MSFT), Apple Inc. (AAPL) and Amazon.com Inc. (AMZN) for a plain-vanilla iShares S&P 500 ETF .
In the past year, both the iShares ETF and the competing Invesco ETF have handily beaten the wider market, gaining about 10% compared with almost 3% for the S&P 500 fund.
The iShares ETF is the second-most-popular of 2019, based on new money raised, while the competing Invesco ETF ranks 11th, according to FactSet.
“We’re on the downside of the cycle, so there’s more of a hunger for risk-mitigation strategies,” said Nick Kalivas, senior equity ETF strategist for Invesco.
Both ETFs aim to smooth out market upheaval, but they are built quite differently.
The iShares ETF draws on the more than 600 stocks in the MSCI USA index and aims to invest in those with the lowest volatility and projected “riskiness.” The fund rebalances twice a year and imposes “guard rails” to make sure that no sector diverges more than 5% from its weight in the underlying benchmark.
By contrast, the Invesco fund picks the 100 least volatile stocks from the S&P 500 in the past year, rebalances quarterly and imposes no sector constraints. At the end of January, the Invesco ETF had nearly 43% of its holdings in real estate and utility stocks, while the iShares ETF had about 17% of its assets invested in those two sectors, according to Morningstar.
Those differences can translate into sizable gaps in performance. In the fourth quarter, when the iShares S&P 500 ETF dropped more than 14%, the iShares ETF fell 8.1% and the Invesco fund dropped 5.7%.
“You win by losing less when markets are choppy,” said Holly Framsted, head of U.S. factor ETFs at BlackRock Inc.’s iShares division.
But investors can win less. So far this year, while both the iShares and Invesco low-volatility ETFs are up about 10%, they trail the S&P 500’s 11% gain.
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