The financial-market turbulence that arose in the last quarter of 2018 is still fresh in investors’ minds, making portfolio defence a prominent theme in 2019. This has been felt in the sizeable inflows of capital into defensive strategies, including low-volatility ETFs.
The US equity fund space is a useful case in point. Out of 27 low-volatility equity ETFs in the US market today, two large cap-focused equity products stand out: the iShares Edge MSCI Min Vol U.S.A. ETF (USMV), and the Invesco S&P 500 Low Volatility ETF (SPLV).
“These two ETFs command roughly [US$40 billion] in combined assets, and they keep on growing,” reported ETF.com. From a year-to-date perspective, they’ve taken in US$7 billion in net creations between them — remarkable when considering that all US equity ETFs have seen US$14 billion in net combined inflows within the first five months of the year.
As notions of slowing global growth, ongoing tariff wars, Brexit, and a shifting outlook on interest rates float among the economic tea leaves, many ETF investors have adopted a risk-averse attitude. That has helped low-volatility ETFs do well this year, with both USMV and SPLV outdoing the benchmark-tracking SPDR S&P 500 ETF Trust (SPY) as of June 10.
An under-the-hood examination of USMV shows a broad portfolio of over 200 securities selected from the MSCI USA universe, whereas SPLV’s 100-name portfolio is derived from the S&P 500. USMV also differs from SPLV in that it doesn’t target the lowest-volatility names, but considers correlation among its holdings.
“USMV focuses on building a minimum volatility portfolio,” FactSet Director of ETF Research Elisabeth Kashner told ETF.com. “It optimizes for the lowest volatility portfolio, which might contain stocks with elevated volatility but negative correlation to the rest of the basket.”
The fund also eschews sector concentration risk, capping sector weights to within 5% of their weightings in the broad market. That’s in contrast to SPLV, which selects the 100 lowest-volatility members of the S&P 500 and weights them based on volatility, disregarding sector constraints.
“[SPLV’s] simple portfolio construction creates significant sector over- and underweights,” Kashner said.
Sector tilts can also impact overall performance. Tech-sector members of the S&P 500 are reportedly up by around 25% year-to-date, compared to just 5% for health care. But within the past month, the S&P 500 has struggled to break even, while utilities and health care sectors have rallied about 2.5% — which means SPLV, which rebalances quarterly, has offered better downside protection from the market tumbles of recent weeks than USMV.
There’s plenty of similarity between the two funds. Aside from the presence of 75% of SPLV’s holdings within USMV’s portfolio, both of them have a beta of around 0.7, indicating that they deliver a ride that’s 30% smoother than what one would expect from the S&P 500.
But USMV might still hold the edge with an expense ratio of 0.15% compared to SPLV’s 0.25%. That’s not to mention its US$28.1 billion in AUM and US$207 million in average daily trading volume, in contrast to SPLV with US$11.5 billion in assets and US$139 million in average daily volume.
“Size and liquidity are often an attention grabber for institutional investors,” said Todd Rosenbluth, senior director of ETF and Mutual Fund Research at CFRA. “The MSCI suite of indices is more widely used from a factor perspective, even though the low vol part of S&P/Dow is quite prominent.”
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