Anxiety in financial markets is high these days, but can some of the newer ETFs help investors ride the storms more smoothly?
It’s hard to tell what’s coming next, with debt concerns in the U.S. and Europe, a jobless recovery and weak housing prices all conspiring to make financial planning difficult. The problem is what to do about it.
With that challenge in mind, I’ll look at some of the newer, defensively focused ETFs first. As I noted in a recent blog, a fistful of funds launched in May aimed at delivering portfolios with specific qualities like low volatility or high beta.
Two funds among these have gained popularity with investors: the Russell 1000 Low Volatility ETF (NYSEArca: LVOL) and the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV). LVOL has gathered about $44 million in assets, while SPLV has more than $128 million.
Both strive to provide a basket of equities with a specific risk characteristic: low volatility of returns. Volatility, also known as standard deviation, measures the variation of returns around their average. Put another way, volatility reflects whether you rode a roller coaster or drove across flat Midwest plains on the way to your returns.
Neither fund explicitly attempts to estimate forward volatility. Each, instead, relies on recent historical volatility. Beyond this point, their methodologies diverge.
LVOL looks at returns over the past 60 days. It picks stocks from the Russell 1000, putting those with the lowest volatility at the top of the list. It selects stocks from the top down until the market-cap amounts to 35 percent of the Russell 1000. It then selects additional names in an attempt to manage turnover, beta and momentum. The weighting scheme is also complex, but can be summarized as a tiered equal weight.
SPLV takes a longer view. It measures volatility over the past year in its S&P 500 universe. It picks the 100 funds with the lowest volatility and weights them accordingly.
Traditionally defensive economic sectors like consumer noncyclical and utilities play large roles in both portfolios. These two sectors together make up about two-thirds of SPLV’s exposure.
LVOL also has significant exposure to the same two sectors, but it shows greater economic diversity by virtue of double-digit holdings in industrials, energy and tech. (See sector table below.)
LVOL rebalances monthly, and SPLV rebalances quarterly, so these sector tilts may not persist. Because the funds don’t use cap-weighted schemes, their rebalances may produce more significant turnover than your average equity fund.