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August 01, 2016 at 05:24 AM
Following the initial slide in stocks after Brexit, prices jumped into record high territory while volatility collapsed. But unlike previous generations that blindly chased stocks at will because of rising prices, today’s investors, with the help of ETFs, have been more cautious.
Instead of pouring money into higher risk segments of the stock market like mid and small caps, today’s ETF investors are favoring funds that reduce market gyrations by owning stocks with less volatility.
The top five funds built to cut market volatility, including the iShares Edge MSCI Minimum Volatility USA ETF (USMV), pulled in almost $13 billion in net assets through June 30, according to Morningstar. It’s an impressive feat considering that fund investors liquidated about $52 billion in U.S. stock funds against the backdrop of slumping volatility.
ETFs that minimize stock market volatility, also known as “low-volatility” or “low-vol” funds, aim to reduce market gyrations by screening for stocks with lower betas. For example, stocks with a beta under one will generally be less volatile than the overall market. Stocks with a beta above one generally have a higher volatility. If a stock’s beta is 1.3, for instance, its volatility is expected to be 30% higher compared to the broader stock market.
USMV holds a basket of 177 publicly traded U.S. stocks including General Mills (GIS) Johnson & Johnson (JNJ), and PepsiCo (PEP). The average equity beta for the USMV’s portfolio is just 0.68%.
Since the start of the year, the S&P 500 has gained 6.3% while the VIX – a measure of volatility – has sunk 35%. During the same period, low-volatility ETFs like USMV, along with the PowerShares S&P 500 Low Volatility ETF (SPLV), have delivered market-beating performance, gaining around 12% year-to-date, almost twice the returns of the S&P 500.
Despite the love affair with low-volatility ETFs, these products were only introduced during the aftermath of the 2008-2009 global financial crisis and have yet to face a period of chaotic markets.
Whenever new investment products are launched – and low-volatility ETFs are still relatively new – a certain element of market timing and luck is involved. Ideally, product sponsors want to release ETFs in market conditions that will benefit the fund’s strategy and performance, and that’s exactly what’s occurred with low-volatility ETFs over the past several years.
Since 2009, the VIX has been crushed and fallen almost 70% while the U.S. stock market has soared just over 200%.
