SPLV Vs. USMV: 2 Defensive ETFs Help Preserve Your Wealth

(This article was co-produced with Hoya Capital Real Estate.)

As I wrap up this article on Monday, May 9, 2022, shortly after the close of another horrible day in the market, the Dow Jones average sits some 12.73% down from its 52-week high. With declines of 17.17% and a rather mesmerizing 28.31%, respectively, the S&P 500 and Nasdaq indexes have fared even worse.

But it goes deeper than that. Foreign stocks have fared no better. And fixed income? The sharpest and quickest rise in interest rates in many years has led to substantial declines in this area as well. As a result, even my fairly conservative ETF Reliable Retirement Portfolio, targeted at investors at or nearing retirement age, is down 11.78% since its inception if evaluated on the portfolio positions themselves. If dividend income is factored in, things look just a little better, at 10.58% overall.

In the midst of all of this, one of the bright spots for me has been the performance of Invesco S&P 500 Low Volatility ETF (NYSEARCA:SPLV). Using the ETF Reliable Retirement Portfolio as a reference, while the overall portfolio has declined by 10.58% since inception, SPLV has produced a positive return of 1.05% in terms of share price, and even more when dividends are factored in.

Given that, I thought it was time to take a second look at this ETF and how it might fit into your portfolio. As a bonus, I am going to also take a look at iShares MSCI USA Min Vol Factor ETF (USMV), another top-flight ETF that plays in the same space, so to speak. We will take a look at their similarities, and differences, as well as whether a clear winner can be picked between the two. Finally, I will offer a link to further reading on something known as the marginal utility of wealth.

Invesco S&P 500 Low Volatility ETF

SPLV seeks to track the investment results of the S&P 500 Low Volatility Index. Here, from the fund’s summary prospectus, is an explanation of the construction of this index.

The Underlying Index is designed to measure the performance of the 100 least volatile stocks in the S&P 500 Index. Volatility is a statistical measurement of the magnitude of up and down asset price fluctuations (increases or decreases in a stock’s price) over time. The Index Provider measures the realized volatility of every stock in the S&P 500® Index using available price return data for the trailing one year of trading days leading up to each index rebalancing date. The 100 stocks with the lowest volatility comprise the Underlying Index. The component securities are weighted by the inverse of their volatility, with the least volatile stocks receiving the greatest weights.

The index is rebalanced quarterly, after market close on the third Friday in February, May, August, and November.

Boiled down a little more simply, what does this all mean? We get a clue from an Infographic that Invesco provides for the fund.

If you look at the top paragraph, you will see reference to “access to the low volatility factor with no sector constraints.” Put differently, the index does not consider how constituents interact with one another. Since recent volatility tends to persist in the short term, in general this tends to be a solid approach when combined with SPLV’s quarterly rebalancing schedule.

Interestingly, this is exactly what has led to SPLV’s solid recent performance, as referenced above. In the case of the ETF Reliable Retirement Portfolio, the absolute strongest performer has been Vanguard Utilities ETF (VPU). Almost to the day since Russia invaded Ukraine, this sector has performed extremely well.

With this in mind, take a look at SPLV’s sector breakdown, as well as Top 10 holdings, as displayed in this nice combination graphic from Seeking Alpha.

Likely, what jumps out at you is that for the recent period, Utilities have comprised almost 25% of SPLV’s holdings. This is also reflected in its Top 10 holdings. And what is the second-highest-weighted sector? Consumer Defensive. Again, look at the Top 10 holdings for major names leading the fund. Likely, you recognize the names of companies whose products sell in both good and bad times.

Now, here is the only downside of that approach. Because of SPLV’s “unconstrained” approach to security selection, it often has huge sector biases relative to the broader market. One recent period where this did not work out so well was during the coronavirus-induced market sell-off in early 2020. Here is how a recent Morningstar report summarized this period:

With almost half of its portfolio packed into real estate and utilities, this fund was caught flat-footed when it was tech, communications, and healthcare stocks that held up among the best. The fund lost 1.87 percentage points more than the S&P 500 index from Feb. 19, 2020, through March 23, 2020, and . . . trailed by a wide margin in the subsequent recovery.

However, to be fair, if one examines SPLV over a period of several years, this appears to be the one period where the fund could be said to have failed. As featured in Invesco’s infographic displayed above, SPLV has tended to capture 73% of the market’s upside potential, and only 60% of the downside. Certainly, this has been the case during the downturn we find ourselves in now.

iShares MSCI USA Min Vol Factor ETF

USMV seeks to track the investment results of the MSCI USA Minimum Volatility Index. Similar to what I did above for SPLV, let’s start with some key information from USMV’s summary prospectus.

Under the rules-based methodology, securities and weightings of the Underlying Index are determined based on pre-established parameters and discretionary factors are not relied on.

Generally, the rules-based methodology includes specified requirements for security eligibility, maximum and minimum weightings by security and, in some cases, by sector . . ..

In order to determine weightings of securities within the Underlying Index, MSCI seeks to optimize the Parent Index such that the resulting portfolio exhibits the lowest absolute volatility, as measured by MSCI, while applying constraints based on turnover, established minimum and maximum weightings of index constituents and sectors, as well as factor constraints (for example, liquidity and financial leverage) as measured by MSCI. (Bold mine)

The MSCI index focuses on large- and mid-cap stocks. Please notice, however, the text I bolded in the above quote. In contrast to SPLV, USMV’s methodology specifically prevents the fund from incurring excessive weighting in any one sector. Again, in contrast to SPLV, USMV is constructed with an optimizer that considers stocks’ individual volatility as well as how their performance interrelates with other holdings.

With this in mind, take a look at USMV’s sector breakdown, as well as Top 10 holdings, as displayed in this nice combination graphic from Seeking Alpha.

Now, if you compare the Top 10 holdings of the two funds, you will see some similarities. First, in a very positive way, stocks in both funds are fairly evenly weighted. Neither fund, then, becomes terribly overweighted in a few names.

However, you likely also noticed significant differences. For example, the Utilities and Consumer Defensive sectors, which currently comprise some 48.12% of SPLV, only comprise 22.91% of USMV. In stark contrast, Technology holds a 17.88% weighting in USMV, as opposed to a rather paltry weighting of 2.39% in SPLV.

USMV rebalances semi-annually, as opposed to quarterly. Additionally, there is a 10% cap on one-way turnover at each rebalance, keeping transaction costs low.

SPLV vs. USMV – Can We Pick A Clear Winner?

Here is where things get interesting. Now that we’ve taken a look at each ETF, and their similarities and differences, can we pick a clear winner?

Before we go any further, one difference that may be important to some investors is that SPLV pays its dividends on a monthly basis, whereas USMV pays on a quarterly basis. So, if you are an investor who would like a little monthly income from equities, in addition to what you likely receive from most bond ETFs you hold, SPLV may be the winner for you based on that item alone.

Here’s another bit of information for you to consider. Given everything I laid out above, I got to wondering about the level of overlap between SPLV and USMV. So, with the help of a nice tool at etfrc.com, here’s a quick look.

In the above graphic, we find that there is a 37% overlap between the two funds. On the right-hand side, we see graphically displayed the differing focus with respect to Utilities/Consumer Staples vs. Technology due to the different selection methodologies.

Next, a breakdown of significant non-overlapping exposures.

Again, you likely see the same features playing out here as well.

With all that in mind, I decided to run a multi-option backtest in Portfolio Visualizer. Here’s a link to the results, for any interested in taking a closer look. The backtest runs from 2015 to the present. All dividends are taken into consideration and reinvested. The portfolios are rebalanced semi-annually, which will really only come into play for the combination analysis I feature at the end. Finally, I use the Vanguard 500 Index Investor as a benchmark.

Here are my 3 “portfolios.” Portfolio 1 is 100% SPLV, Portfolio 2 is 100% USMV, and Portfolio 3 is a 50/50 mix of the two.

In the next graphic, please note carefully which colored line matches up with each portfolio. The green line represents our benchmark.

Over the long term, USMV appears to be the clear winner in the comparison. In terms of absolute return, its CAGR bested SPLV by some .63% over the period. Even better, it managed to do so with a lower standard deviation and max drawdown. SPLV’s one “win” comes in the Worst Year measure where it was no worse than -4.14%.

At the same time, I can’t help but note that SPLV has outperformed USMV over the most recent period, down a mere 2.78% YTD as opposed to a 6.85% decline for USMV.

And that leads to Portfolio 3, a 50/50 mix of the two ETFs. Given the fact that the two methodologies gave way to fairly differentiated holdings, I wondered if blending the two might lead to higher risk-adjusted returns. Long story short, it simply does not appear that it does. I picked a simple 50/50 split as a baseline to test the theory. But I went a step further. I used Portfolio Visualizer’s optimization tools, where it searches for the best asset mix to achieve a goal, such as highest Sharpe ratio. The answer? 100% USMV.

Summary and Conclusion

Per all of the above, clearly USMV comes out the winner in this comparison.

Having said that, readers might notice that the difference is not a huge one. And, as featured, there are occasions, such as recently, when SPLV’s methodology has proved at least temporarily advantageous. Finally, as I featured earlier, an investor who values monthly dividend income might select SPLV simply due to that particular feature.

Finally, in the Portfolio Visualizer backtest featured above, astute readers likely noticed that there is a price to pay for the defensive potential offered by either SPLV or USMV. Namely, that both will underperform during extremely bullish markets. However, particularly for those at, or nearing, retirement age, a recent article I wrote on the topic of Risk Tolerance And The Marginal Utility Of Wealth might prove beneficial reading. It offers an interesting glimpse into the rewards, but also the risks, of both approaches. If nothing else, I hope it is interesting food for thought.