Low Vol Goes Small In PowerShares ETFs



The PowerShares S'P SmallCap Low Volatility Portfolio (XSLV) and the PowerShares S'P MidCap Low Volatility Portfolio (XMLV) launch Friday Feb. 15, as noted by my colleague Cinthia Murphy.

Creating a small-cap low-vol ETF may seem an odd choice at first. After all, small-caps typically appeal to those investors willing take on more risk in the hopes of higher returns and presumably wouldn’t attract the Nervous Nellies who reach for lower-risk funds.

However, the of the success iShares MSCI Emerging Markets Minimum Volatility Index Fund (EEMV) refutes this idea. Emerging markets aren’t exactly defensive plays either, but EEMV has well over $1 billion in assets since its launch a short 16 months ago.

Indeed, EEMV’s success suggests that low-vol investors aren’t Nervous Nellies at all, but are instead true believers in the low-vol premise and are willing to apply it across the equities market.

But how well does this low-vol premise work?

PowerShares’ press release for XSLV and XMLV touts the strong risk-adjusted performance of its large-cap los-vol sibling, the PowerShares S'P 500 Low Volatility Portfolio (SPLV).

And why not? I compared SPLV’s performance since inception against the plain-vanilla, market-cap-weighted SPDR S'P 500 ETF (SPY) and found higher returns, lower risk (measured by standard deviation and by beta) and risk-adjusted outperformance (alpha).

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This impressive tally of statistics is doubtless influenced by the time period of the measurement, or more accurately, by the condition of the overall market during that period.

All else equal, a low-vol strategy will do better in falling markets and in choppy markets, but will lag in a steady upswing.

This regime sensitivity is plain to see when measured from market peak to trough. I borrowed the charts below from a low-vol discussion at InsideETFs earlier this week.

Here I’m using the total return indexes under SPLV and SPY, respectively, since SPLV itself does go back that far.

The pattern is plain to see:Low vol offered downside protection in a bear market but lagged when the bulls ran.


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Indexes Peak Trough


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Indexes Trough Now

Using the same metrics as above, we find that volatility is lower in both periods, just as the charts suggest. What’s more interesting is the risk-adjusted outperformance (statistically significant alpha) in the bull market but not in the bear market.


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This set of snapshots suggests better absolute performance in the bear markets and better relative performance in the bull market—not a bad combination.

Would-be investors in XSLV and XMLV will no doubt hope for similar performance.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at pbritt@indexuniverse.com.


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