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Keep Volatility at Bay With Smart Beta ETF

This article was originally published on ETFTrends.com.

Among smart beta exchange traded funds dedicated to individual investment factors, low volatility products have been popular with conservative investors based on the premise that emphasizing a low volatility strategy can help reduce a portfolio’s downside potential.

The iShares MSCI USA Minimum Volatility ETF (Cboe: USMV) , the largest US-listed low volatility ETF, looms large in the low volatility ETF conversation. The $15.36 billion USMV is almost seven years old and tracks the MSCI USA Minimum Volatility (USD) Index. Its approach has been solid for most of the fund's lifespan.

“So far, the fund's approach has worked well. From November 2011 through July 2018, the fund exhibited 17% less volatility and about a third less market sensitivity than its parent index,” said Morningstar in a note out Friday. “And while it lagged the benchmark by 103 basis points annually during that time, it still generated better risk-adjusted performance than most of its peers.”

USMV holds 206 stocks and the fund's three-year standard deviation is 8.32%, putting it below the S&P 500 based on that volatility metric.

Deeper Dive to Reduce Volatility

Investors should be advised that simply because USMV looks to reduce volatility, that does not mean its performance will constantly be impressive.

“Performance will not always be strong. The fund will likely lag during bull markets and probably won't generate market-beating returns over the long-run,” said Morningstar. “But it should hold up better than most of its peers during downturns and offer better risk-adjusted returns than the MSCI USA Index over a full market cycle. Its holdings may be priced to offer attractive returns relative to their risk because their tendency to lag in bull markets can make them unattractive to benchmark-sensitive investors.”

None of USMV's holdings exceed weights of 1.57%. Unlike many rival low volatility strategies, USMV features a large technology weighting at almost 22%. The defensive healthcare and consumer staples sectors combine for almost 26% of the fund's weight.

“This fund doesn't directly target stocks with low volatility, though it still heavily favors them. It considers expected individual stock volatility and correlations across stocks, under a set of constraints, like limiting sector tilt,” according to Morningstar.

The research firm rates USMV Silver.

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