Since the third quarter began, the S&P 500 Index has surged or plunged by one percent during more than 40 percent of the trading sessions. While some investors are taking the neck-snapping moves as a cue to reduce exposure to the market, many others are standing pat.
Perhaps the best path is to maintain market exposure while side-stepping volatility. That’s the promise of low-volatility or minimum-volatility ETFs. “They allow investors to be in the market in a less risky way,” says Todd Rosenbluth, director of ETF and mutual fund research at CFRA.
These funds appear to be delivering on their mandates in these choppy markets. “They’ve been performing this quarter just as they have been designed to do,” says Alex Bryan, director of passive strategies at Morningstar. Earlier this year, these ETFs proved to be more volatile than expected due to interest rate moves. More on that in a moment.
Bryan’s sentiment that these ETFs are doing better in the latest market turmoil is backed up by the numbers. For example, the iShares Edge MSCI Min Vol USA ETF (USMV) fell 5.6 percent at the market’s late-October nadir and is now down two percent this quarter. In contrast, the S&P 500 lost about 9 percent in the early weeks of the quarter and is still off more than six percent. The Invesco S&P 500 Low Volatility ETF (SPLV) dropped more than 4 percent in October has rebounded to just about break-even.
The cost of entry to these funds aren’t high. The iShares fund, which has $18 billion in assets, is just 0.15 percent. The Invesco fund, which has a much more modest $8 million in assets, has a still-reasonable 0.25 percent.
These funds reduce volatility by focusing on low-beta stocks. Beta measures how much a stock moves in relation to the broader market, and a stock with a beta of 1.0 means it's correlated to the S&P 500. The beta for the typical holding in the iShares Edge MSCI Min Vol USA ETF, for example, is just 0.67. For the Invesco fund, it’s even lower at 0.58.
Not Just For Defense
Here’s the curious thing. You’d expect low-beta stocks to lag in a bull market. In fact, the literature for various low-volatility funds stress that they are built to deliver slightly lower long-term returns in exchange for fewer big swings. Yet these funds have actually exceeded their benchmarks over extended time frames.
The iShares Edge MSCI Min Vol USA ETF, for example, has outgunned the S&P 500 by an average of 62 basis points annually over the past five years. That fund’s global counterpart, the iShares Edge MSCI Min Vol EAFE ETF (EFAV), has returned around 5.6 percent per annum over the past five years, more than double the return of its benchmark, the MSCI All-World Country Index (ex U.S.). That fund carries a 0.20 percent expense ratio and has $8.8 billion in assets.
“These funds have performed especially well during pullbacks, which has led to better overall returns,” says Bryan.