Where Risk Lurks In Low-Vol Fund ‘SPLV’

December 19, 2014

Very Different Funds

As of the end of November, of the 10 sectors making up the S&P 500, information technology was the largest, with 20.0 percent of the market capitalization of the entire index. The financial sector was second, at 16.3 percent, while telecommunication services was the smallest sector and utilities was the second-smallest sector, with just 3.1 person of the market capitalization of the entire index.

But weightings are very different for the S&P 500 Low Volatility Index. The largest sector, by far, is the financials sector, which accounts for 32.5 percent of the Index; the second-largest sector is utilities, which accounts for 17.5 percent of the Index. Information technology, the largest sector in the broad S&P 500, accounts for just 2.8 percent of the Low Volatility Index.

The two largest sectors in the S&P Index account for just 36.3 percent of the total index. The two largest sectors in the Low Volatility Index account for exactly 50.0 percent of the index. SPLV isn’t based on a lower-volatility version of the S&P 500, it’s based on something very different, as you can see, because SPLV’s constituents are selected without regard to sector but merely because they exhibit lower volatility.

S&P_Sector_Breakdown

 

SPLV_Sector_Breakdown

These weightings mean that SPLV is much more correlated to the utility sector than is the broad-based S&P 500 Index. In fact, SPLV has a weighting in utilities that is about five times greater than the S&P 500. And the defensive names that make up the consumer staples sector? They’re underweighted in the Low Volatility version.

SPLV: Utilities Fund In Disguise

In many ways, SPLV is a utility ETF. The correlation of SPY to the Utilities Select Sector SPDR Fund (XLU | A-90) is just 65 percent, while SPLV’s correlation to XLU is 84 percent. Is that a bad thing?

It certainly hasn’t been for SPLV, as low interest rates have made utilities, and SPLV, big winners. And while lower volatility is a great attribute over time, being overweight utilities is an asset allocation decision that might not be so great if interest rates increase dramatically.

The takeaway? Your ETF’s theme is important. But the next few paragraphs on the fact sheet—the paragraphs that explain how it applies that theme—may be more important.


At the time this article was written, the author held a position in SPY. Follow Scott on Twitter @ScottNations.

 

 

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