A Small Low Vol ETF For Higher Rates
This low-vol fund may shine if the Federal Reserve raises rates in the next month or two.
There's a small low-volatility ETF that could be about to have its day in the sun, and stand out relative to the heavyweights in the segment—funds like the $13 billion iShares Edge MSCI Min Vol USA ETF (USMV | A-69) and the $7 billion PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-70)—when interest rates begin to rise.
By and large, low-vol ETFs have been hugely popular this year as investors try to navigate a choppy market and an uncertain macroeconomic outlook. USMV, the largest ETF in the segment, has raked in more than $5 billion in fresh assets year-to-date, while SPLV, the segment's No. 2 ETF, has gathered $1.1 billion.
Smaller Fund Keeps Up
The much-smaller PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (XRLV | D-72), meanwhile, has attracted $17 million in net creations in the same period. The fund has only $132 million in total assets.
To be fair, XRLV is still a newcomer into the space, having been launched about a year ago, while USMV and SPLV have been around since 2011. But the fund has been performing well, much like its competitors, as the year-to-date chart below shows. And that performance could improve in a rising-rate environment.
Chart courtesy of StockCharts.com
"Investor demand for U.S. low-volatility ETFs has been strong thus far in 2016," S&P Capital IQ's Todd Rosenbluth said in a research note. "However, if the Fed does indeed raise interest rates in June or perhaps July, certain high-dividend-yielding securities, such as electric utilities or household product companies, could be negatively impacted if history is any guide."
"Like SPLV, XRLV tracks an S&P Dow Jones index of 100 low volatility stocks, but the latter index excludes stocks that have historically performed poorly in rising rate environments," he added.
While USMV aims to minimize the volatility of its portfolio by holding a basket of stocks that together have low-volatility characteristics, SPLV simply holds the 100 least volatile stocks in the S&P 500.
How XLRV Mitigates Higher Rates
XRLV, meanwhile, aims to mitigate downside linked to rising interest rates by removing the 100 names from the S&P 500 that have tended to fare the worst when rates rise (using a five-year comparison with 10-year Treasurys.)
In practice, that translates into different sector tilts as well as some unique portfolio holdings. From a sector perspective, XRLV has bigger allocations to financials, industrials and health care sectors relative to both USMV and SPLV. The fund also has twice the allocation to tech stocks than that found in SPLV, Rosenbluth notes.
Ownerships Costs Are Higher
More specifically, allocations to names such as Equifax (EFX), Thermo Fisher Scientific (TMO) and Motorola Solutions (MSI) could help the fund's performance going forward, he noted.
XRLV does face a bigger hurdle in the form of costs. The fund carries an 0.25% expense ratio, but it trades with an average spread of nearly 0.20%, putting its total cost of ownership at about $45 per $10,000 invested. The fund trades on average about $485,000 a day.
USMV costs 0.15%, and trades with an average spread of 0.02%. SPLV costs 0.25% and also trades with an average spread of 0.02%. That puts the overall cost for USMV and SPLV at about $17 and $27 per $10,000 invested, respectively—significantly lower than XRLV's.
Contact Cinthia Murphy at [email protected]
