One of the hottest trends in investing is boredom.
After several months of manic volatility in stock markets, fund companies are busily introducing exchange-traded funds (ETFs) that cater to a growing appetite for low-volatility stocks. Rather than touting their ability to deliver outstanding profits, these funds emphasize their ability to deliver steady returns in stormy times.
The question is whether the new products can squeeze the excitement out of investing without sacrificing too much of the reward. But there is little doubt that investors are eager for products that can shield them from gyrations like those of the past few months, when stock markets have oscillated madly between bull-market euphoria and bear-market fears of a double-dip recession.
“The past several years have been extraordinarily volatile, and that has shaken a lot of investors out of the market,” said John Gabriel, an ETF strategist at Morningstar Inc. “These new products are trying to strip out that volatility. There’s demand for it among investors.”
Many of the low-volatility ETFs hold shares in consumer-staples companies and energy utilities – the traditional defensive sectors that chug along no matter what the broader economy does.
Most select their holdings using a concept known as beta, which measures how sensitive a stock is compared to the broad market. A stock with a beta of 1 rises and falls in line with the index, while a stock with a beta of less than 1 gyrates less than the market.
Typical is Bank of Montreal’s new BMO Low Volatility Canadian Equity ETF , which made its debut last week. It picks the 40 stocks with the lowest betas among the 100 largest and most-liquid Canadian shares.
Other contenders include the iShares MSCI USA Minimum Volatility Index Fund . Russell Investments and Invesco Ltd. began offering low-volatility ETFs in May.
Before jumping into these new ETFs, investors should be aware of some potential pitfalls.
It’s not clear, for instance, whether it’s the right time to buy into these products. Many defensive sectors, such as utilities, have been bid up in recent months as investors have sought out potential havens. Buying into these industries now may mean purchasing them near peak valuations.
In addition, standard market theory holds that lower risk means lower returns on average. However, that tradeoff may not be as axiomatic as once thought. Russell Investments published a paper in June showing that an index of low-volatility defensive stocks outperformed a basket of high-volatility dynamic stocks in some cases.
“Contrary to what you might expect, portfolios that are optimized for low volatility … tend to have very good returns,” said Lukasz Pomorski, assistant professor of finance at the University of Toronto’s Rotman School of Management. “Quite often the low-risk portfolio will actually perform better [than a higher-risk alternative]”
Returns from any strategy can be hard to predict and low volatility is no exception. Sam Lee, an ETF analyst with Morningstar, said low volatility stocks tend to lag behind in massive bull markets. “A low-volatility strategy during the nineties would have underperformed the market by well over 10 per cent annualized,” he said.
“But the great thing about low volatility is … during bear markets when every other stock is getting killed, these strategies don’t lose as much money.”
Investors who have already tilted their holdings toward safer, dividend-paying sectors may find that the new funds simply duplicate many of their current holdings.
“A defensive investor or a risk-averse investor may already be in that sort of a fund, so they need to check how it will play in the overall portfolio and interact with existing holdings,” Mr. Gabriel said.
No thrills, please
iShares MSCI USA Minimum Volatility Index Fund
This fund seeks to mirror the price and yield of the MSCI USA Minimum Volatility Index.
BMO Low Volatility Canadian Equity ETF
Selects the 40 stocks that are least sensitive to the market out of the 100 largest and most liquid stocks in Canada.
Russell 1000 Low Volatility ETF
Seeks to match the return of the Russell-Axioma U.S. Large Cap Low Volatility Index.
PowerShares S&P 500 Low Volatility Portfolio
The fund is based on the S&P 500 Low Volatility Index (Index), which consists of the 100 stocks from the S&P 500 with the lowest volatility over the past 12 months.
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