The Compelling (And Simple) Case For Low Volatility ETFs

ETF Database

May proved to be a brutal month on Wall Street, as equity markets across the board plummeted into red territory. Poor U.S. economic data coupled with revived Euro Zone tensions painted a grim picture for the future of the global economic recovery. With investors watching their bottom lines quickly erode, many are looking for ways to minimize their exposure to the riskier and more volatile segments of the market [see also Three High-Yielding Monthly Dividend ETFs].

Enter Low Volatility ETFs. With over a dozen products to chose from, this ultra popular category of ETFs has raked in close to $2 billion in aggregate assets. Intuitively, these products are very appealing, especially for risk averse investors. But, as many investors have learned the hard way, compelling ideas don’t always translate into compelling performances [see our Low Volatility ETFdb Portfolio].

The month of May turned out to be an interesting testing ground for low volatility ETFs; many stock indexes endured their worst performance in multiple years, posting losses of 5% or more. Below we outline five low volatility ETFs, and show how that stacked up against their “plain vanilla” counterparts (results are four-week return figures, as of May 31):

S&P 500 ETFs: May 2012
PowerShares S&P 500 Minimum Volatility Portfolio (SPLV) -1.26%
State Street SPDR S&P 500 ETF (SPY) -5.59%

State Street’s infamous SPY took a major hit this month, while PowerShares’ low volatility S&P 500 Fund managed to come out on top. SPLV shed only 126 basis points compared to SPY’s significant drop of 5.59%.

MSCI EM ETFs: May 2012
iShares MSCI Emerging Markets Minimum Volatility Index Fund (EEMV) -9.07%
iShares MSCI Emerging Markets Index Fund S&P 500 ETF (EEM) -10.45%

Although emerging markets are down across the board, the MSCI Emerging Markets Minimum Volatility Index Fund has succeeded to outperform its counterpart EEM, but only by a slim margin.

MSCI EAFE ETFs: May 2012
iShares MSCI EAFE Minimum Volatility Index Fund (EFAV) -7.04%
iShares MSCI EAFE Index Fund (EFA) -10.02%

Given Euro Zone drama taking center stage yet again this month, it perhaps is not surprising to see both of these EAFE targeted funds deep in red territory. EFAV’s minimum volatility portfolio did however fare better than EFA’s double digit losses.

Russell 1000 ETFs: May 2012
Russell 1000 Low Volatility ETF (LVOL) -3.35%
iShares Russell 1000 Index Fund (IWB) -5.72%

These Russel 1000 funds, which are designed to target large cap U.S. companies, both took on significant losses in May. The low volatility ETF, LVOL, did however outperform iShare’s IWB by 237 basis points.

Russell 2000 ETFs: May 2012
Russell 2000 Low Volatility ETF (SLVY) -5.19%
iShares Russell 2000 Index Fund (IWM) -5.59%

In general, small cap stocks tend to exhibit higher levels of volatility than their large cap counterparts. And since the Russell 2000 represents the small-cap segment of the U.S. equities market, it is not surprising to see both SLVY and IWM post losses over 5%; the low volatility ETF, however, managed to minimize its losses by a slight margin.

Verdict

As shown above, low volatility ETFs proved to be quite effective during the miserable month of May. Though all of the low vol funds highlighted above posted losses, they fared quite well compared to the broad-based index funds from which they draw their holdings. Investors who scaled back risk exposure with low volatility ETFs in May managed to limit downside losses, putting them in better position than those who held traditional beta during this period.

Follow me on Twitter @DPylypczak

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Disclosure: No positions at time of writing.

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