Are Low Volatility ETFs Actually Safer?

Investors who have jumped into low volatility equity ETFs believing that they’d get market returns at a fraction of the risk might now be getting a lesson in how these funds really work. With market volatility at record low levels, low volatility ETFs have looked more like S&P 500 index funds in 2017. The 14% year-to-date return of the PowerShares S&P 500 Low Volatility ETF (SPLV) trails the S&P 500 (SPY) by 3%, as tech and healthcare, two areas not typically favored by low volatility funds, have outperformed.

But low volatility ETFs aren’t sold on their returns. They’re sold on their risk reduction capabilities. These funds should be expected to underperform in bull markets, when their more traditional value investing style falls out of favor. It’s in down markets when low volatility funds earn their keep. But even in up markets, those lower returns should be offset by lower risk, producing risk-adjusted returns that should be at least comparable to the broader market, right?

Well, lately that hasn’t been the case.

It’s been about one year since the 2016 election, when equities really started rallying. During that time, the Low Volatility ETF has returned a total of 18% compared to a 23% return for the S&P 500. Again, that’s not surprising given that the growth style has significantly outperformed value. What is surprising is the risk profile of both the fund and the S&P 500 over that time.

The Low Volatility ETF has actually been MORE risky than the broader market. Low volatility ETFs that focus on higher yielders, such as the PowerShares S&P 500 High Dividend Low Volatility ETF (SPHD), have delivered an even lower return an an even higher risk level. Not exactly what investors in these funds signed up for, I’m sure. Also concerning right now is the fact that there doesn’t appear to be a whole lot of value in the fund right now. The Low Volatility ETF has a P/E ratio of 20.5 and a P/B of 3.22. Compare that to a 19.4 P/E and a 3.1 P/B for the S&P 500 and you’re looking at a fund that doesn’t have a good value proposition right now.