Low-Volatility ETFs Are Doing Their Job

Many low-volatility ETFs are actually doing what they promised: delivering smaller losses in down markets.

The idea behind low-vol funds: Buy stocks with the lowest up-and-down moves. In theory, these stocks will suffer less in a down market.

Two important corollaries to the theory:

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1. They also will tend to rise less in up markets. Risk and return are joined at the hip: If you want lower volatility when the market is down, you’ll get it when the market is up, too.
2. They still will fall in a down market. These are, after all, stock ETFs, and when the broad market falls, they will swoon along with it. Don’t buy one of these if you can’t stand to see your investment fall in value at all.

Because these funds are less volatile, you’re less likely to panic and sell in a downturn. And, because your losses will be smaller than a garden-variety ETF, you should return to profitability faster than an ETF that simply tracks the Standard & Poor’s 500-stock index.

Special mention should be made of these three low-vol ETFs:

1. Fidelity Low Volatility Factor ETF (FDLO, $31.91) has fallen 4.93% since the S&P 500’s Sept. 20 high, while the index has tumbled 6.08%. The past 12 months the fund is up 11.59%, vs. 8.84% for the S&P 500.
2. Franklin LibertyQ U.S. Equity ETF (FLQL, $29.86), down 5.80% since the market high and 9.93% for the past 12 months.
3. Invesco S&P 500 Minimum Variance ETF (SPMV, $29.02), down 5.60% since the market high and 9.20% for the past 12 months.

Look carefully to see how the ETFs construct their portfolios. Invesco S&P 500 Low Volatility ETF (SPLV, $47.35), for example, simply invests in the 100 least volatile S&P 500 stocks and gives the least volatile stocks the highest weighting. The fund reconstitutes its holdings every quarter.

iShares Edge MSCI Min Vol USA ETF (USMV, $54.11) uses the MSCI USA Index, a somewhat more comprehensive index that includes mid-cap names. The fund picks the least volatile stocks within each industry sector, ensuring greater diversification.

Here’s the rundown on large-company blend low-volatility ETFs and how they have performed as of Oct. 11. Dividends and gains are reinvested. Data via Morningstar.