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Sometimes things are not always as they seem when it comes to investing.

For example, you’d expect that two exchange-traded funds with similar mandates would generate roughly comparable results. But it doesn’t always work that way, as I learned once again while doing some research in response to a reader’s question.

He wanted some guidance as to the best choice in a low-volatility ETF that invests in U.S. stocks. I expected to find a differential in returns of a fraction of a percentage point between the leading contenders. What I discovered was quite different.

Before I give you the details, here’s a little background. Many investors have been spooked by the decline in the stock markets this year and worries of a coming recession. Companies that were viewed as the gold standard a year ago have seen their share prices plunge. Names such as Shopify Inc., Meta Platforms Inc. (Facebook), and Zoom Communications Inc. have been hammered.

It’s not just tech companies that have been beaten down. Aecon Group Inc., CI Financial Corp., First Quantum Minerals Ltd., Magna International Inc., NFI Group Inc. and Onex Corp. are among the many stocks in the S&P/TSX Composite Index that are down more than 20 per cent year to date. Those losses are more than double the decline of the broad index.

In the past, I have recommended the use of low-volatility ETFs to minimize the damage. They invest in low beta stocks – those that consistently display below-average volatility.

Here’s how they work. An index such as the S&P 500 or the TSX Composite has a beta of one. Stocks with a beta of more than one will tend to have greater volatility than the broad market, which means they’ll move up or down at a disproportionately higher rate. In short, bigger gains or losses. Those with a beta of less than one are seen as low-volatility stocks (less risk). The lower the beta, the less risk – in theory.

Of course, other factors may enter into a stock’s valuation, and low beta stocks aren’t immune from broad market movements. But, in theory, these stocks should hold up better in a falling market while underperforming when shares are rising.

My Internet Wealth Builder recommendation of the BMO Low Volatility Canadian Equity ETF (ZLB-T) is holding up quite well this year compared with the TSX Composite. Our reader wanted advice about a similar type of ETF that focuses on U.S. stocks. He also asked for guidance on choosing between a hedged and unhedged fund.

We already have one fund of this type on my newsletter’s recommended list: the iShares Edge MSCI Minimum Volatility USA Index ETF (CAD-Hedged) (XMS-T). But I decided to revisit the sector to see if there is anything better. It’s a good thing I did.

The iShares fund is designed to replicate the performance of the MSCI USA Minimum Volatility 100% Hedged to CAD Index. An unhedged version trades under the symbol XMU-T.

The ETF was launched in April, 2016, and, with XMU, has been popular with investors, with about $350-million in assets under management. The MER is 0.33 per cent.

XMS ended 2021 at $34.68 and dropped as low as $28.49 in mid-June. It has since recovered to $31.43. Including distributions of $0.179 per unit, it’s down 8.9 per cent year to date. That’s unimpressive at first glance, but keep in mind that the S&P 500 is off 13 per cent for 2022. This fund may be down, but it’s holding up better than the broad index. The five-year average annual compound rate of return to July 31 is 8.45 per cent.

Not a bad result. But another ETF that looks much the same on the surface has outperformed it by a wide margin in recent months. It’s the BMO Low Volatility U.S. Equity Hedged to CAD ETF (ZLH-T).

Like the iShares entry, this ETF was launched in 2016 and has an MER of 0.33 per cent. But that’s where they part company. The iShares fund is index-based, while the BMO ETF is actively managed by BMO Global Asset Management. The result is a wide divergence in portfolios and total returns.

The iShares portfolio is evenly balanced, with no stock representing more than 2 per cent of the assets. Some of the best-known holdings include T-Mobile US Inc., Cisco Systems Inc., Texas Instruments Inc., Johnson & Johnson and PepsiCo Inc. In terms of sector allocation, information technology is No. 1 at 23.06 per cent, followed by health care at 18.76 per cent and consumer staples at 11.39 per cent.

The BMO portfolio, while also evenly weighted, looks very different. Top holdings include Campbell Soup Co., Dollar General Corp., Kellogg Co., Domino’s Pizza Inc., Northrop Grumman Corp., Dollar Tree Inc. and Merck & Co.

The sector composition is strikingly different from the iShares ETF. While XMS has 23 per cent of its assets in information technology, BMO has only 4.1 per cent. The top BMO sectors are consumer staples (21.83 per cent, almost double the iShares allocation), utilities (19.8 per cent versus 7.8 per cent) and health care (15.1 per cent, a little less than XMS).

The difference in the two portfolios has translated into a significant performance edge for the BMO entry in 2022. As of July 31, it was showing a small year-to-date gain of 0.05 per cent compared with a loss of 9.01 per cent for XMS. The three-year average annual compound rate of return was 9.88 per cent (5.52 per cent for XMS), while the five-year BMO number was 10.03 per cent versus 8.45 per cent.

However, those numbers don’t tell the complete story. Between 2017 and 2020, the iShares fund outperformed the BMO ETF every year. In 2021, the two were very close. It’s the big outperformance this year that has skewed the cumulative results in BMO’s favour. That can be traced directly to the large information technology position in XMS.

As they say in the business, past results are no guarantee of future returns. But the most recent returns make a strong case for choosing either ZLH or its companion unhedged version if you’re in the market for a U.S. low-volatility ETF right now.

I usually prefer the hedged version of these ETFs because it eliminates one variable from the equation – currency exchange rates. But if the U.S. dollar is strong against the loonie, the unhedged version will produce better returns.

Gordon Pape is the editor and publisher of the Internet Wealth Builder and Income Investor newsletters.

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