Where Risk Lurks In Low-Vol Fund ‘SPLV’

December 19, 2014

This is a weekly column focusing, usually, on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options. More than 94 million options on ETFs were traded in November, and because ETFs and options are among the fastest-growing financial vehicles in the world, it only makes sense to combine the two. While today’s piece is a departure from the norm, this column typically highlights unusually large or interesting ETF options trades to help readers understand where traders believe a particular ETF may be headed. In doing so, Nations will examine the underlying options strategy.

It’s usually option traders discussing volatility, but low volatility can be a good thing for every investor. After all, while a lot of volatility can lead to oversized returns if a stock or ETF appreciates, elevated volatility can also mean a higher likelihood of a stock or ETF falling below the initial purchase price. Hence, there’s higher risk in high volatility.

There aren’t many successful investors who like risk, so it’s not surprising that the PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-45) has attracted $5 billion in assets since it was launched less than four years ago. SPLV tracks the S&P 500 Low Volatility Index, which consists of the 100 stocks in the S&P 500 with the lowest realized volatility over the previous 12 months.

Low volatility has specifically been good for owners of SPLV, as you can see from the comparison of the return for SPLV and the broader market as defined by the SPDR S&P 500 ETF (SPY | A-99) since SPLV was introduced. SPLV has actually outperformed SPY over that period on an absolute basis, and it’s done so with volatility—as measured by standard deviation of annualized returns—that’s about 25 percent lower.

It would seem that SPLV is the best of all possible worlds, better returns—a good thing; and lower risk— an even better thing. But if you’re thinking that SPLV is just a lower-risk version of the S&P 500, you’d be wrong. SPLV is very different than the larger S&P 500.

SPY_Vs_SPLV

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