Investors often turn to low volatility exchange traded funds, such as the Invesco S&P 500 Low Volatility Portfolio (SPLV ), when broad market volatility spikes, pressuring higher beta, growth sectors and riskier assets.
The low-volatility ETFs are factor-based strategies that tilt toward companies with a propensity for lower volatility. Different issuers and index providers arrive at a basket of low volatility stocks in varying fashions. Historical data confirm that over long holding periods, the low volatility factor is rewarding for investors.
“The S&P 500 Low Volatility Index outperformed the U.S. equity benchmark between February 1972 and November 1990, both in absolute terms and on a risk-adjusted basis,” according to S&P Dow Jones Indices. “Its higher annualized returns and lower volatility than the S&P 500 resulted in a risk/reward ratio of 0.98, which was similar to the ratio observed during the latter period. Hence, the S&P 500 Low Volatility’s returns were similarly compensated for the risks being taken in the 1970s and 1980s compared to the period since December 1990.”
SPLV tracks the S&P 500 Low Volatility Index, a collection of the 100 S&P 500 members with the lowest trailing 12-month volatility.
Among smart beta exchange traded funds dedicated to individual investment factors, low volatility products have been popular with conservative investors based on the premise that emphasizing a low volatility strategy can help reduce a portfolio’s downside potential.
“While both indices posted similar average monthly total returns during the two distinct periods – before Dec. 1990 and since Dec. 1990 – the hit rates show that the low volatility index was slightly better (worse) at beating the S&P 500 during up (down) months before December 1990,” notes S&P Dow Jones. “Although this contributed to the low volatility index capturing a greater proportion of S&P 500 returns in the earlier period – it typically captured around 90% of the equity benchmark’s monthly gains and 65% of the S&P 500’s monthly declines – the S&P 500 Low Volatility index still offered upside participation and downside protection.”
Low-volatility factor investments work on the idea that they help cushion against market turns, limiting drawdowns that investors experience while providing upside potential. Consequently, the low- or min-vol strategies may produce better risk-adjusted returns over the long haul, which has been backed by extensive academic research.
“Given these characteristics helped the low volatility index to outperform the broad-based market benchmark, the history extension provides further evidence of the potential advantage of focusing on the least volatile constituents in a given market,” according to S&P Dow Jones.
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