The past few years have seen extreme volatility in the stock market. And this has sparked curiosity about a special brand of exchange-traded funds: low-volatility ETFs.
True, the stock market is doing pretty well in 2023 thanks to an increased appetite for riskier assets – including many beaten-down growth stocks. But it's worth remembering that uncertainty was the name of the game in 2022, and it may be premature to sound the "all clear."
Indeed, there are still plenty of unanswered questions for investors, including those surrounding the Federal Reserve's future monetary plans, the recent bank crisis and the debt ceiling. "Volatility is the watchword for the next few months," says Nancy Tengler, chief investment officer and CEO of wealth advisory firm Laffer Tengler Investments.
Pros and cons of low-volatility ETFs
If you're looking to get back into the market in a responsible way, or if you're simply looking to rejigger your portfolio to reflect the new reality on Wall Street, low-volatility ETFs are an interesting option. They allow investors access to the stock market, but with a lower risk profile than the typical index fund.
However, it's important to know that while these funds can often reduce overall volatility over longer time periods, they still can suffer mightily against sudden market shocks. So, make sure to check what's inside. The simple fact that they're meant to reduce volatility doesn't mean they're immune.
It's also worth noting that even the best ETFs to buy for low volatility carry the risk of underperformance. As the old saying goes, higher risk often can result in higher returns and excluding more dynamic companies might hold your portfolio back in the long run. But if you want additional peace of mind or are more concerned with capital preservation than growth, the following nine low-volatility ETFs all have something to offer.
Data is as of May 3. 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: $10.2 billion
- Dividend yield: 2.2%
- Expenses: 0.25%, or $25 annually for every $10,000 invested
The largest and most-established option among low-volatility ETFs is the Invesco S&P 500 Low Volatility ETF (SPLV, $63.26). It commands more than $10 billion in assets, and provides the most liquid option out there, with average volume that is around 3 million shares on a typical day.
SPLV is a bit more selective than some of the other low vol ETF options on this list. The fund limits its portfolio to only large domestic stocks that are part of the S&P 500 Index, then picks the top 100 names off that list that have the lowest realized volatility over the past year.
The top three holdings in SPLV right now are healthcare stock Johnson & Johnson (JNJ), soft drink giant PepsiCo (PEP) and snack food and drink maker Mondelez International (MDLZ). However, it's worth noting that all are about equal at about 1.3% of the entire portfolio. This is thanks to a regular rebalancing that keeps the money spread around fairly equally.
If you are looking to replace your broad-based large-cap holdings with a low-volatility option, SPLV provides one of the simplest ways to get beyond the standard S&P 500 index funds.
iShares MSCI EAFE Min Vol Factor ETF
- Assets under management: $7.8 billion
- Dividend yield: 2.3%
- Expenses: 0.20%
The iShares MSCI EAFE Min Vol Factor ETF (EFAV, $70.26) is an international version of the prior fund. It focuses on "EAFE" companies instead of domestic ones – that is, stocks headquartered in Europe, Australasia and the Far East.
That doesn't mean they only do business in these regions. Many of EFAV's holdings are multinational names you might recognize. This includes Denmark-based diabetes care giant Novo Nordisk (NVO) and Swiss consumer staples giant Nestle (NSRGY), among others.
When looking at the portfolio by national influence, Japan leads with about 26% of assets, followed by Switzerland at 15% and the U.K. at about 11%.
Though foreign, these countries are quite similar to the U.S. in both their economic might and their investor protections. So if you're looking for low volatility ETFs that provide diversification outside of domestic stocks, EFAV is a great option.
iShares MSCI Emerging Markets Min Vol Factor ETF
- Assets under management: $4.7 billion
- Dividend yield: 1.8%
- Expenses: 0.25%*
Looking even farther afield, the iShares MSCI Emerging Markets Min Vol Factor ETF (EEMV, $55.26) is a low-volatility ETF option that focuses only on emerging markets to provide exposure to these high-growth regions in a lower-risk way. This fund is well-established with about $5 billion in assets at present, proving that even in times of trouble there is a large cohort of investors that are interested in this strategy.
"Stocks listed in emerging markets are usually riskier than their developed-markets counterparts for a variety of reasons," writes Morningstar analyst Daniel Sotiroff. "But EEMV takes some of the edge off by systematically targeting less risky stocks and combining them in a way that's designed to cut back on volatility."
Right now, the breakdown by country is China (26%), followed by Taiwan (19%) and India (13%). By individual holdings, top stocks are the state-run Bank Of China and Taiwan's Chunghwa Telecom (CHT). But with more than 300 holdings, there are plenty of smaller and relatively unknown emerging markets options out there, too.
And with a methodology that prioritizes low volatility over high growth potential, you can have faith that you won't be sticking your neck out on riskiest companies in these regions.
* Includes a 44-basis-point fee waiver.
iShares MSCI Global Min Vol Factor ETF
- Assets under management: $4.6 billion
- Dividend yield: 2.1%
- Expenses: 0.20%
If you don't want to mix and match with multiple low-volatility ETFs from around the world, then consider the iShares MSCI Global Min Vol Factor ETF (ACWV, $99.05), which takes a more comprehensive approach. As the name implies, this global fund holds about 400 large stocks that exhibit low-volatility characteristics. Half the holdings are in the U.S., and the other half are from foreign markets.
"The fund should lag the MSCI ACWI during rallies but hold up better when the market declines," Morningstar's Sotiroff writes. "This should outweigh the upside it sacrifices in bull markets and lead to better risk-adjusted performance over the long haul."
Top low-volatility stocks in the portfolio at present are Big Pharma mainstay Merck (MRK) and trash collection king Waste Management (WM). You'll also find companies from Japan (11% of the portfolio) and China (8%), among others, on this list.
If you're looking for a single holding to invest in a diversified way with a lower risk profile, then this global low-volatility ETF could be worth a closer look.
Invesco S&P 500 High Dividend Low Volatility ETF
- Assets under management: $3.4 billion
- Dividend yield: 4.1%
- Expenses: 0.30%
If you're interested in taking a more tactical approach to low-volatility ETFs than simply layering on a screen by geography, the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD, $40.92) offers an option that looks to reduce your volatility even as it maximizes your income potential.
It does this through a very focused investing strategy, targeting the top 75 stocks in the S&P 500 with the highest dividend yields, though no more than 10 stocks from a single sector can be included. From there, the fund narrows it down to the 50 or so stocks with the lowest volatility.
Right now, leading positions in SPHD include tobacco giant Altria Group (MO) and blue chip telecom stocks AT&T (T) and Verizon Communications (VZ). These picks are representative of the approach of this low-volatility ETF, as it buys into large and entrenched companies with a strong history of dividends.
With a payout that tops even 10-year Treasury bonds, there's a great yield here for those looking for income. But keep in mind that this fund isn't as diversified as some other offerings, with a small list of holdings and a bias toward a handful of sectors. Specifically, SPHD has about 19% in real estate and another 17% in utility stocks – two sectors that have lagged the broader market so far in 2023.
These two sectors have lagged the broader market so far in 2023, and neither has particularly good long-term growth prospects, especially when compared with more dynamic consumer or tech stocks. But if you're looking for stability, this fund could be worth considering.
Invesco S&P MidCap Low Volatility ETF
- Assets under management: $987.4 million
- Dividend yield: 2.3%
- Expenses: 0.25%
Another more tactical way to play low-volatility ETFs is to focus on the next tier of the market down from your usual blue chip stocks. That's where the Invesco S&P MidCap Low Volatility ETF (XMLV, $51.41) comes in. This fund excludes the big guys and instead goes for the "goldilocks" mid-cap stocks that are not too big and not too small.
"These companies have established their competitive positions in the marketplace and validated their products and distribution, which may make them less volatile than their small cap peers," writes Canadian mutual fund and ETF provider Mackenzie Financial. "Mid caps tend to exhibit the staying power of larger businesses but may still have substantial growth opportunities ahead."
Current XMLV holdings include Ohio-based healthcare provider Chemed (CHE), regional utility Idacorp (IDA) and dozens of other stocks that are mostly under the $10 billion mark in overall market value.
These picks are components of the S&P MidCap 400 Index – that is, the next 400 stocks in line when you get past the larger S&P 500 Index of blue chip stocks. And then, XMLV layers on a screen to hand pick the top 20% of companies with the lowest realized volatility over the past 12 months. That gives you a focused list of about 80 solid mid caps.
Vanguard Short-Term Bond ETF
- Assets under management: $37.7 billion
- SEC yield: 4.2%**
- Expenses: 0.04%
Though the words "low volatility" aren't in this ETF's name, there is perhaps no more solid investment out there than highly rated, short-dated bonds. That's what the Vanguard Short-Term Bond ETF (BSV, $76.84) provides exposure to, with more than 70% of the portfolio getting top AAA ratings thanks to a large focus on U.S. Treasuries.
With a focus on highly qualified borrowers and an effective maturity of less than 3 years across the portfolio, this ETF is focused on investments that are all but certain to come through. After all, if Uncle Sam goes bankrupt in the next 24 to 36 months, we all have bigger problems than our retirement accounts!
What's more, a rising interest rate environment has pushed the yields of this short-term fund up to significant levels that are roughly three times the dividends you'll find in a typical S&P 500 stock. That is a good source of income as well as a decent hedge against future declines.
** 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.
iShares Preferred and Income Securities ETF
- Assets under management: $12.7 billion
- Dividend yield: 6.5%
- Expenses: 0.45%
Similar to bonds, preferred stock is a special class of investment that gets prioritized over common stock and comes with a much larger dividend payment. It's still subordinate to bonds and debt holders in the event of a default, giving it a higher risk profile, but it's less volatile and "preferred" by many income investors to common stock.
The iShares Preferred and Income Securities ETF (PFF, $30.00) is one of the most popular ways to play this trend, with a massive portfolio of almost 500 individual holdings. These include preferred stock from utilities like PG&E (PCG), financials like Wells Fargo (WFC), industrials like ArcelorMittal (MT) and other mature and capital intensive companies that regularly need to raise cash through preferred stock.
One word of warning: Banks are one of the most common issuers of preferred stock, so about two thirds of this fund is in the financial sector. This could certainly be a concern given the recent volatility in regional bank stocks. But given the lower volatility profile of preferred stock vs common stock, along with the high income potential, that still makes PFF worth a look.
Utilities Select Sector SPDR Fund
- Assets under management: $20.5 billion
- SEC yield: 2.5%*
- Expenses: 0.18%
Historically, utility stocks are among those with the lowest volatility compared with other fast-moving sectors like technology. That's in part because of the fact that power and water are necessities for businesses and consumers alike, with strong baseline demand in any market environment. But the solid nature of utilities is also reinforced by structural factors that include strict regulatory oversight, regional monopolies in some markets, and high barriers to entry from competitors.
The largest utilities ETF out there, the Utilities Select Sector SPDR Fund (XLU, $68.07), is the go to way to play this sector. It holds only about 30 companies, but they are the biggest and most established utility stocks in the U.S. Top holdings include NextEra Energy (NEE), Southern (SO) and Duke Energy (DUK).
As proof of its low-volatility credentials, this fund was relatively flat in calendar 2022, while the broader S&P 500 lost nearly 20%. That shows how utilities can hang tough even when the rest of Wall Street is in trouble.
Jeff Reeves writes about equity markets and exchange-traded funds for Kiplinger. A veteran journalist with extensive capital markets experience, Jeff has written about Wall Street and investing since 2008. His work has appeared in numerous respected finance outlets, including CNBC, the Fox Business Network, the Wall Street Journal digital network, USA Today and CNN Money.
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