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All Contents © 2019The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| December 7, 2018
Volatility is back, and that has investors on the defensive. Huge market swings over prolonged periods of time can be a nightmare, prompting investors to make rash decisions that ultimately hamper their portfolios. And that’s precisely what low-volatility exchange-traded funds (ETFs) are built to battle.
Emotions can be an investor’s worst enemy: Big declines trigger fear. No one wants to lose money, and they certainly don’t want to lose more money. The problem? Some stocks sell off on their own merits, while others merely get temporarily caught up in the current, only to return to proper valuations once volatility has subsided. But anyone who bailed on the way down cemented their losses while leaving themselves out of the recovery.
These seven low-volatility ETFs help fight this instinct. Low-vol funds use different strategies to create portfolios that should be more stabile than the broader market. Not only can that help minimize losses during downturns, but the lack of volatility can help calm investors and prevent them from making rash exits from the market. Take a look.
Data is as of Dec. 6, 2018. Dividend yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Market value: $18.7 billion
Dividend yield: 1.8%
The iShares Edge MSCI Min Vol USA ETF (USMV, $55.95), at nearly $19 billion in assets, is the largest low-volatility ETF by nearly double. It’s also one of the most straightforward examples of what a low-vol fund is trying to accomplish.
USMV uses a multi-factor risk model that examines traits such as value and momentum to come up with a portfolio of large- and mid-cap stocks that are less risky than the broader market. At the moment, that portfolio includes about 210 stocks.
You might expect a heavy dose of traditionally “safe” sectors such as consumer staples and utilities. But in fact, USMV boasts a fairly balanced sector spread. Consumer staples are a decent part of the fund at 12.4% of assets, but information technology (15.7%) and health care (15.5%) are bigger. And utilities make up just 8.4% of the fund – not insignificant, but hardly dominant.
Top holdings are similarly “surprising.” Traditional buy-and-hold names such as Coca-Cola (KO) and Pfizer (PFE) receive top-10 weights, but so do red-hot growth stock Visa (V) and mining giant Newmont Mining (NEM).
Beta, a measurement of volatility, is centered around the number 1 – anything higher is considered more volatile than the markets, while anything lower is considered less volatile. USMV sports a three-year equity beta of 0.66.
Market value: $90.4 million
Dividend yield: 1.6%
The Fidelity Low Volatility Factor ETF (FDLO, $32.24) is a very similar offering that examines a world of the 1,000 largest U.S. stocks based on market cap (which includes large- and mid-cap stocks) and tries to the select the least volatile companies.
Fidelity, which is more open about its methodology, considers three factors equally when determining which stocks to hold:
IT is tops here, too, at 19.4%, followed by financials and health care (14.4% each). What’s interesting is that consumer staples are just 6.9% of the fund, and utilities are 3.1%.
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, roughly $810 billion Apple (AAPL) is 3.9% of the fund versus 1.5% for $205 billion MasterCard (MA). Thus, Apple is four times the size of MasterCard, but has less than three times the influence on the fund.
Market value: $601.8 million
Dividend yield: 3.5%
Several low-vol funds have the same charge: Find the least-volatile large- and mid-cap stocks, rinse and repeat. But a few funds look at different worlds of stocks, or have a few extra twists and tweaks.
The Legg Mason Low Volatility High Dividend ETF (LVHD, $31.09) includes a pretty simple twist. In addition to hunting down stocks with low volatility, it also wants to add more substantial dividends to the mix.
And why not? The thing about low volatility is that it swings both ways – sometimes being more volatile than the market can mean you’re generating more upside, so sometimes reducing volatility actually limits gains. But you can make up some of that difference if you’re drawing returns in the form of larger dividends.
LVHD explores a universe of 3,000 stocks that screens for companies that pay “relatively high sustainable dividend yields.” It then scores companies higher or lower based on price and earnings volatility. From there, it caps any stock’s weight at rebalancing at 2.5%, and any sector’s weight at 25% (except real estate investment trusts, which can never exceed 15% of the fund). Those percentages can move between rebalancing as stocks rise and fall.
The fund typically holds between 50 and 100 stocks. Currently, the 79-stock portfolio is heaviest in utilities (25.9%), consumer staples (19.2%) and REITs (14.8%). The top 10 holdings reflect that, including companies such as healthcare REIT Ventas (VTR), electric utility Duke Energy (DUK) and McDonald’s (MCD).
Market value: $4.7 billion
Dividend yield: 2.6%
Low-volatility ETFs also can be used to rein in much more volatile areas of the market than large caps.
Consider the iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV, $57.46) – a 315-holiding portfolio of stocks from “developing” or “emerging” countries. Countries such as the U.S. and Britain are considered “developed” markets – growth may not be robust, but they have relatively low economic, geopolitical and other risks. Emerging markets, on the other hand, typically boast much higher growth rates, but are less reliable thanks to various factors such as less regulated stock markets, volatile country leadership and higher risk of corruption and graft.
Funds such as EEMV are a way for less risk-averse investors to dip a toe into the higher price potential of these areas. In EEMV’s case, the fund spreads your risk across more than 300 holdings, each selected for its low-volatility characteristics, and none commanding up more than 2% of the fund’s assets right now.
Roughly a quarter of the fund is invested in China, with another 14.9% in Taiwan, 9.2% in South Korea and 8.9% in India. Thailand and Malaysia are among other high-single digits holdings. Also, as is the case across emerging markets, financial stocks such as banks are a high sector weight at 28.7% of assets. Top holdings won’t sound too familiar to the average Joe – they include the likes of Indonesia’s Bank Central Asia and Taiwan’s Chunghwa Telecom.
This fund has been particularly resilient in 2018’s emerging-markets selloff, losing less than 7% versus 15% for the ubiquitous iShares MSCI Emerging Markets ETF (EEM).
*Includes 44-basis-point fee waiver.
Market value: $122.6 million
Dividend yield: 2.1%
Small-cap stocks are another notoriously high-volatility area that the low-vol ETF industry has tried to wrap into a protective blanket.
The O’Shares FTSE US Small Cap Quality Dividend ETF (OUSM, $25.48) is part of the O’Shares family – the brand of investor Kevin O’Leary (aka “Mr. Wonderful”), who you might know from Shark Tank.
OUSM isn’t out-and-out marketed as a low-volatility ETF, but the fund’s goal – to seek out small caps that boast high quality, substantive dividend and low volatility – is essentially the same means that other low-vol funds take to get to their ends. Hence, the ETF typically is grouped right alongside other low-vol ETFs.
The wide bucket of 225 holdings helps mitigate single-stock risk, though there are a few heavyweights in this fund: Leidos Holdings (LDOS), Eaton Vance (EV) and Lazard (LAZ) all were weighted between 2.5% and 3% according to the most recently available data. Past that, OUSM stands out for both its decent dividend for a small-cap fund (2.1%, on par with the S&P 500) and its heavy 20% concentration in industrial stocks – the sector rarely sees top billing in other low-volatility ETFs.
Market value: $1.6 million
Dividend yield: 2.5%
The Invesco U.S. Large Cap Optimized Volatility ETF (OVLC, $30.77) focuses on roughly the same large (and despite the name, mid-cap) stocks that USMV and FDLO select from. What’s different is that OVLC is allowed to be a little more flexible.
Whereas USMV and FDLO constantly focus on lowering volatility, OVLC’s methodology also allows it to chase higher returns “when the ‘reward to risk’ is high.” In theory, Invesco’s ETF may take few chances and remain buttoned up when risk is high and markets are heading lower … but if risk starts to fade and high upside is a distinct possibility, OVLC might “take a few more chances,” so to speak.
The 100-stock portfolio, at the moment, doesn’t exactly appear to be chasing anything speculative. Consumer staples (14.1%) and utilities (13.7%) are top sector weightings. And top holdings such as Johnson & Johnson (JNJ), Microsoft (MSFT) and Exxon Mobil (XOM) are stereotypically “safe” blue-chip plays.
It’s an interesting strategy, though performance has been mostly similar to USMV since inception in 2016. Investors also must weigh one significant downside: OVLC has attracted very few assets and has low volume as a result. That leads to choppier trading – which is what you want to avoid in a low-volatility vehicle.
New York Life
Market value: $85.1 million
Dividend yield: 4.7%*
Lastly, the IQ S&P High Yield Low Volatility Bond ETF (HYLV, $23.66) is a horse of a different color in that it’s a rare stab at taking the low-vol theme to the bond market.
The HYLV attempts to straddle the gap between the high yield of below-investment-grade (“junk”) bonds and their relatively high risk. The underlying index selects bonds using a calculation that factors in the bond’s duration (a measure of its sensitivity to interest rates), the bond’s spread (the difference between its yield and a similar-maturity U.S. Treasury bond’s yield) and the spread of the broader universe of bonds that the fund is selecting from.
In practice, the results in what boils down to a basket of bonds that mostly resides in the highest credit ratings. Roughly 84% of the portfolio is invested in BB-grade bonds (the highest tier of junk), then more than 15% is in B-grade. A whisper of the fund is in CCC debt.
The flip side? A considerably lower yield of 4.7% compared to the 6%-plus SEC yields on the popular SPDR Bloomberg Barclays High Yield Bond ETF (JNK) and iShares iBoxx $ High Yield Corporate Bond ETF (HYG). Yes, HYLV’s movements tend to be less drastic than either of those funds, but it tends to lag in total returns.
*SEC yield reflects the interest earned after deducting fund expenses for the most recent 30-day period and is a standard measure for bond and preferred-stock funds.