Are Low-Volatility ETFs For Real?

Any equity investor who wasn’t thinking about volatility before is almost certainly focused on it now. Bull markets? We get it. Bear markets? We hate them, but for better or worse, here, too, we get it. Flash crashes? Even those, we at least have learned to recognize for what they are. But the sort of roller coaster we’ve been experiencing lately, how on earth do we play those? Everything is easy to evaluate in retrospect. But before the fact, when we must make our decisions, we still seem lost. Some nouvelle ETFs think they have an answer.

Back to Basics – Oops I Mean Beta

As discussed in an 8/11/15 post, Beta is a well-known Nobel-Prize-pedigree indicator that tells us how volatile and asset is relative to a benchmark (e.g., such as the S&P 500 if we’re talking about equities). A beta of 1.00 means the asset is exactly as volatile as the benchmark. A beta of 1.30 means the asset is 30 percent more volatile than the benchmark. A beta of 0.90 means the asset is 10% less volatile.

Note: None of these ETFs are disclosing their secret sauces, nor should we expect them to. I have no idea which ETFs, if any, actually use Beta as part of their modeling. I’ll be using it here, not as a predictor of anything but as a tool to evaluate what’s been accomplished in the past.

Risk reduction, low beta, is not supposed to be a free lunch. According to theory (hard-core theory with that Nobel Prize aura) there’s supposed to be a risk-reward tradeoff. As you reduce risk, you’re presumed to be reducing your expected returns. Expected returns must always positive. (Who in this galaxy deliberately invests to lose money?) We make the tradeoff by accepting a lesser positive return than we think we could otherwise get if we were to be more aggressive.

ETF Providers On the Job

In a way, it’s amazing it took ETF providers as long as it did to come up with low-volatility offerings (note the inception dates below), but whatever, at least the cavalry is here – maybe.

Table 1

Ticker Fund Inception Assets ($ mill.) Avg. $ Traded (60 days) CFA Compass EMP US 500 Volatility Weighted 7/2/14 8.7 53.0 LGLV SPDR Russell 1000 Low Volatility 2/21/13 27.8 146.1 SLOW ALPS ETF Trust ALPS Sector Low Vol 7/1/15 2.4 16.5 SMLV SPDR Russell 2000 Low Volatility 2/21/13 32.4 156.2 XMLV PowerShares S&P MidCap Low Volatility 2/15/13 108.8 517.0 XSLV PowerShares S&P SmallCap Low Volatity 2/15/13 112.3 628.3