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Low-volatility ETFs see mounting investor interest

ETF.com Managing Editor Cinthia Murphy joins Yahoo Finance's Kristin Myers to break the outlook on low-volatility ETFs amid the coronavirus pandemic.

Video Transcript

KRISTIN MYERS: And now, it's time for our ETF report brought to you by Invesco. Joining us now to chat this is Cinthia Murphy, Managing Editor of ETF.com. Thanks so much for joining us, Cinthia.

Now, I was reading one of your notes a little bit earlier, and you were noting that essentially low-vol hasn't given the performance one might have hoped in these volatile times. I was reading earlier that, you know, that might have changed over the last couple of weeks. Are you seeing a shift at all, you know, to the outperformance of value stocks from growth stocks?

CINTHIA MURPHY: Yeah. It's been a very interesting year for factor investing for sure. The type of strategy that worked so well last year, like low-vol, min-vol type of funds that, you know, kind of give you that smoother ride you would expect to be your go to type of strategy now you're like 2021 volatility has gone through the roof. But in reality, these funds have all underperformed the market, some of them by double digits, and because low-vol stocks have not worked well in these ETF portfolios.

But it has nothing really to do with the factor volatility. It has everything to do really with sector exposure. So a year like 2020 when, you know, things that you would find in low-vol vault portfolios, like utilities, real estate, your typical defense stocks, have been just creamed this year. They were-- you know, people are worried about can you pay your electric bill, can you pay your rent? So these are sectors of the economy that got hurt really bad in March, a little bit in April, you know, given the pandemic, the economic shutdown and all that stuff. And these were the biggest names in low vol portfolios.

So it was-- it became-- what was, you know, your safety net actually became the biggest drag in your performance. And in the last couple of weeks, what we're seeing is a lot of these portfolios rebalance quarterly. So they had to just watch their returns go down for the last quarter, because a lot of them are index based.

And just now, they're rebalancing and reallocating these sector positions and finding that nowadays your lowest volatility names are in sectors like technology, right? Who would have guessed? Talk about a turn of events in 2020. And health care and communication services. And so you've been seeing a big shift in sector allocation within these portfolios.

KRISTIN MYERS: So to that end, you know, with the sectors not all doing equally well, talk us through the divergence that you've seen in some of these ETFs. I know you mentioned the SPLV, the SPY in your report. Talk us through that split that you saw there and how they did in comparison to the USMV.

CINTHIA MURPHY: So the biggest difference in this space, and it's one that I think a lot of investors lose in the conversation is the difference between low vol and minimum vol. So the biggest ETF in this space is USMV, which is a nice shares fund. And it's a minimum volatility portfolio. It's truly not a low-vol portfolio, because it's not giving you a portfolio of the lowest volatility stocks in the S&P 500. Instead, it's actually-- it looks at the correlation between stocks, it looks at sector constraints, because if you're going to buy your lowest vol stocks period, you're going to have huge sector bets. If you happen to have it, you know, multiple portfolio utilities, well, that's where low vol is. USMV manages for that.

So you don't have big sector tilts. You don't have big bets that really deviate from the market. So it gives you an absolute lower vol performance. It's about 25% less volatile than the broader market, but it's not really your low-vol true pure low-vol exposure.

The portfolios that were true low-vol portfolios like, you know, LGLV, for example, from State Street and some others, they just don't worry about what sector they're investing in, they're just looking for lowest volatility. And that has been the bumpiest ride of them all. So that's why you've seen such a disparity in the performance of these funds. And it's whether you're really a true believer in the low-vol factor or you just want a, you know, smoother ride overall, in which case USMV is much more popular.

KRISTIN MYERS: Cinthia, you know, before we go, I have to ask you about this, because I'm looking again at the markets right now. Dow is up almost 2% right now. So really, how should investors be thinking about their portfolios over the next couple of months and through to the end of the year?

CINTHIA MURPHY: Well, you know, as it pertains to low-vol factor, if you think about it, there is plenty of reason for uncertainty in the future, right? We have an election year, like you were just mentioning. You have the pandemic that's still unresolved. Now you have, you know, all the protests, the riots. You have geopolitical risk. You have China trade.

There's so many uncertainties that suggest volatility is going to stay heightened throughout the year. And you know, from just investor behavior, it's a lot harder to digest losses than it is to get excited about gains. So I think the place here for low volatility investing remains intact in the sense that, you know, you're looking now to minimize your downside. But it's not, you know, guaranteed money in your pocket, for sure. Anytime you're factor investing, you are taking that factor risk. And in 2020, low-vol has given you risk more than return.

KRISTIN MYERS: All right. Cinthia Murphy, Managing Editor of ETF.com with that ETF report from Invesco. Thank you so much.

CINTHIA MURPHY: My pleasure.