Market Correction Could Boost Low Vol ETFs

Lower volatility ETFs have had it rough from the start of 2020.

Reviewed by: Todd Rosenbluth
Edited by: Todd Rosenbluth

Key Takeaways

  • Investors have recently shunned the two most popular lower volatility ETFs. Since the beginning of 2020, the iShares MSCI USA Min Vol Factor ETF (USMV) and the Invesco S&P 500 Low Volatility ETF (SPLV) have seen $11 billion of net outflows.
  • With SPLV’s latest reconstitution, the ETF increased exposure to information technology, but remains underweight this and other cyclical sectors relative to the S&P 500 and USMV. 
  • CFRA thinks the stock market will need to correct soon before climbing higher, as many market indicators are near extreme levels. Lower volatility approaches have historically, but not always, provided more downside protection.


Fundamental Context

Lower volatility ETFs have been out of favor since the start of 2020. Last year, USMV and SPLV incurred redemptions of $4.5 billion and $2.9 billion, respectively, the fourth- and eighth-highest among equity ETFs, according to CFRA’s First Bridge ETF database.

While SPLV recovered a modest $246 million to start 2021, USMV shed another $3.8 billion. The collective lack of demand is not surprising, as in the year ended Feb. 19, SPLV lost 7.2% in value, while USMV declined 1.1%, significantly lagging the S&P 500 Index’s 18% gain. However, past performance is not indicative of future results, and the $29 billion USMV and $8.4 billion SPLV remain among the largest U.S.-listed smart-beta ETFs.


Chart 1: Net Flows for Previously Popular Low Volatility ETFs ($B)

Source: CFRA’s First Bridge ETF database. As of February 19, 2021.


Smart beta ETFs incur more turnover than market-cap weighted ETFs to stay true to their mandates. Unlike the S&P 500 Index, which makes limited changes at seemingly random times, ETFs focused on lower volatility and other smart-beta investment styles will be reconstituted on a set schedule during the year as the broader stock universe is rerun through screens predetermined by the index provider.

For example, SPLV is reconstituted on a quarterly basis, most recently last week, to own the approximately 100 least volatile stocks in the S&P 500 Index.

With this February reconstitution, just six names cycled out, which was the fewest in the index’s 10-year history according to S&P Dow Jones Indices. With the rebalance, the weighting in health care shrunk to 22% from 25%, while the information technology’s position rose to 8% from 6%. However, exposure to both sectors remains different than the S&P 500 and peer USMV as shown in Chart 2. 


Chart 2: Select Sector Weightings for Lower Volatility ETFs (% of assets)

Source: CFRA’s First Bridge ETF database. As of February 19, 2021.


Although the ETFs sound the same, and over the long run provide similar downside protection for equity investors, USMV and SPLV are constructed differently and hold many distinct securities.

USMV is more diversified across the sectors than SPLV, as it has bands preventing deviation by more than 500 basis points. USMV generally holds the least volatile stocks within a sector, while also incorporating optimizing tools to project the riskiness of the securities.

For example, USMV had a 24% weighting in information technology, less than the 28% for the S&P 500 Index, but much more than SPLV. USMV is reconstituted semiannually, not quarterly, most recently at the end of November.

Next Decline

According to CFRA, it is not a question of “if,” but “when,” the next meaningful market decline will occur.

Sam Stovall, chief investment strategist thinks several market indicators continue to hover near extremes, implying that the S&P 500 Index needs to correct before climbing much higher.

In a recent Sector Watch piece, he cited concerns about all-time highs for the S&P 500 market cap to nominal GDP (140% versus the near 60-year average of 62%) and margin debt compared to the S&P 500; the growth-value differential remaining at levels reminiscent of the early months of the 2000-2002 bear market; and that more than 90% of S&P 1500 subindustries were trading above their 200-day moving average for the 15th consecutive week for only the fourth time in 25 years.

Stovall is particularly worried that, should a decline start shortly, the cyclical energy, financial and materials sectors may underperform in the coming correction as they currently have the greatest recent gains to surrender.  


Chart 3: Additional Sector Exposure of Popular Lower Volatility ETFs (% of assets)

Source: CFRA’s First Bridge ETF database. As of February 19, 2021.


During the latest index reconstitution, there were no changes to SPLV’s exposure to these strong-performing sectors, with the ETF remaining underweight the financials (7% vs. 11%) and materials (2.0% vs. 2.6%) sectors, and owning no energy companies (2.7% of the S&P 500).

Lower volatility ETFs typically offer downside protection more than upside potential. The S&P 500 Low Volatility index, which SPLV seeks to replicate, incurred a muted level of standard deviation relative to the broader S&P 500 Index on a three-, five-, and 10-year basis, as shown in Chart 4, but lower risk-adjusted returns. For example, on a five-year basis, the “low vol” index has a standard deviation of 12.4, less than the 15.0 for the “500”, but a Sharpe ratio of 0.85 compared to 1.08.


Chart 4: A Track Record of Lower Volatility (%)

Source: CFRA’s First Bridge ETF database. As of February 19, 2021.


However, SPLV has not always held up better in the recent past. For example, between March 2 and April 17 of 2020, SPLV declined 9.2%, losing more ground than the S&P 500 Index’s 6.7% loss. Such weakness likely has stuck in the minds of investors.


According to Stovall, stock market declines are swift and sharp, with investors acting like hyperactive first-graders playing musical chairs, always attempting to anticipate when the music will stop.

However, they would be better-suited not letting their emotions become their portfolio’s worst enemy by selling, and instead focus on managing their portfolio to match their risk tolerance.

Lower volatility ETFs provide exposure to historically lower risk securities, which, for some investors, matters more than upside potential.


All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. For more information and disclosures, please refer to CFRA's Legal Notice at

Copyright © 2020 CFRA. All rights reserved. All trademarks mentioned herein belong to their respective owners.

Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence’s equity and fund business in October 2016. Follow him at @ToddCFRA.