Popular ETFs designed to track low-volatility stocks are crushing the market this year thanks to the outperformance of defensive sectors such as consumer staples and utilities.
“This shows that assuming higher risks by buying higher volatility has not paid off this year, at least up to this point,” writes Michael Harris at the Price Action Lab blog. “Conservative investors are the winners because they have provided the fuel for this market rally.”
For example, the $4.9 billion PowerShares S&P 500 Low Volatility Portfolio (SPLV) has posted a total return of 16.1% so far in 2013, versus a 10.2% gain for the S&P 500, according to Morningstar. [Low-Volatility ETFs Still Thriving as Market Wobbles]
On a sector basis, SPLV has 24.3% of its portfolio in consumer staples and 31.3% in utilities.
Investing in the lower-volatility stocks of the S&P 500 has paid 50% more than the index itself “contrary to what financial economics predict,” Harris notes. [Low-Volatility ETFs Enjoy Their Time in the Sun]
“Or does this mean that eventually the spread will close in favor of risk takers? The market will provide the answer in the months to follow,” he added. “But for now, conservative investors are profiting at the expense of risk takers.”
One tenet of modern financial theory is that investors are rewarded for taking on more risk with higher returns. Volatility measures the tendency of an asset to jump around in price, and is often used as a proxy for risk.
However, several academic studies have found that low-volatility stocks actually perform better than “riskier” companies. Risk-adjusted performance makes low-volatility strategies look even better. [Comparing the Two Largest Low-Volatility ETFs]
Investors seem to be noticing. The iShares MSCI USA Minimum Volatility ETF (USMV) is one of the best-selling funds this year, gathering $2.3 billion of inflows. It now holds about $3.3 billion in assets under management. The ETF is up 15.2% year to date.
PowerShares S&P 500 Low Volatility Portfolio
The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.