The Most Important ETF Of 2016

May 17, 2016

There are more than 1,900 ETFs listed in the U.S., and each one of them has a story to tell. At some point, some entrepreneur or innovator decided that this ETF would at least partially define the future of investing, and would matter to investors around the world.

Through April 2016, 772 ETFs had attracted net inflows from investors this year. The factors driving those flows are interesting for all products, but one stands out to me as more telling than the rest: the iShares Edge MSCI Min Vol USA ETF (USMV | A-69).

USMV is part of the new breed of "smart beta" ETFs that aim to use quantitative strategies to deliver superior risk/return results to investors. As the name suggests, USMV offers a low-cost portfolio of U.S. stocks that aim to deliver similar upside performance to the broad-based U.S. equity market with lower volatility.

Through April 30, USMV had pulled in $4.7 billion in net new money, making it the second-most-popular ETF of 2016, trailing only the SPDR Gold Trust (GLD | A-100). Thanks in part to those inflows, USMV had $12.4 billion in assets at the end of April, making it also one of the 50 largest ETFs on the market.

3 Key Reasons Behind USMV's Success

The rise of USMV is impressive for three key reasons:

1. It proves smart beta can scale.

USMV is the largest true smart-beta ETF in the world. Some might argue that funds like the $29 billion iShares Russell 1000 Growth ETF (IWF | A-93) or the $21 billion Vanguard Dividend Appreciation ETF (VIG | A-77) count as "smart beta," and academically, I'd agree. But both of those products are linked to "old school factors"—style and dividends—that have been around for more than 50 years. USMV is the first of the new, modern, factor-focused ETFs to exceed $10 billion in AUM. Its success helps vault smart beta into the mainstream and will embolden other ETF issuers to invest heavily into promoting similar products.

2. It proves that second-to-market ETFs can win.

Another impressive (and for the industry, important) thing about USMV is that it was not the first, and for many years was not the largest, minimum-volatility ETF.

The minimum-volatility space was opened up by the PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-70), which launched in May 2011 and quickly brought in billions in assets. USMV launched five months later, and for awhile, lagged SPLV by assets.

SPLV is still a large and very successful fund—it has $7.1 billion in assets—but USMV has been able to steal the leadership position by offering a different—and to some observers, better—portfolio.

Specifically, the chief criticism of SPLV has been that it tends to overweight certain sectors like utilities, because it has a super-simple methodology that simply chooses the 100 lowest-volatility stocks in the S&P 500.

The fund is currently 14.1% utilities, compared with the 3.5% weight of that sector in the S&P 500. USMV, by contrast, uses the counter-correlations between individual stocks to create a low-volatility portfolio, even while holding some higher-volatility stocks, and constrains its sector overweights so that (for instance) it is only 8.8% utilities right now.

Chart courtesy of StockCharts.com

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