NEW YORK -- Investors are flinging money at low-volatility exchange-traded funds at a record pace in hopes of protecting their portfolios from wild swings in equity markets, but they may not get all the coverage they expect.
That's because there are dramatic differences in the way these ETFs -- designed to dampen volatility -- are constructed. Some of these "low-vol" funds tend to make sector bets, and their performance may diverge significantly.
So far this year, investors have put $2 billion into low volatility ETFs, while the CBOE Volatility Index, .VIX, has jumped more than three percentage points over the past four and a half months, reaching 15.45 percent on February 18. Inflows this year in the category are already more than in all of last year.
It’s unclear which ETF methodology will ultimately be the most effective in protecting investors from volatility in the event of a market downturn.
For example, the $5.7 billion PowerShares S&P 500 Low Volatility Portfolio has no constraints on what sector bets it can take, meaning that at times it is heavily weighted in specific industries. It tracks the S&P 500 Low Volatility Index, which is made up of 100 stocks with the least volatility over the past year.
Currently 18 percent of its portfolio is in financials and 14 percent is in real estate. A bank or real estate sell-off could hit that fund harder than others.
"I do worry that some of these things might have gotten a little top heavy," said Dave Nadig, chief investment officer of ETF.com, an ETF research firm. "We just came out of the biggest bloodbath in financials and real estate that the world has ever seen."
PowerShares said the index methodology it uses can flag securities before they become volatile. For example, since the utilities sector has become more volatile over the past few months, it has reduced its position to 17 percent of its portfolio, down from 24 percent in August.
On the other end of the spectrum is the $4.6 billion iShares MSCI USA Minimum Volatility ETF, which tracks the MSCI USA Minimum Volatility Index.
That index, which includes low-volatility mid- and large-cap U.S. equities, limits sector exposure to within 5 percentage points of what the broader MSCI USA Index owns.