We’re starting to see a new spike in market volatility. After hitting a one-year peak in early March, the CBOE Volatility Index fell by almost half over the following four weeks.
But now it’s gradually climbing again as investors contemplate the long-term effects of the Ukraine war, soaring inflation, rising interest rates and the continuing impact of the pandemic on supply chains and global growth.
Volatility is a measure of the swings in price of an index or a specific stock. Assets that have high volatility are deemed to be riskier. They are known as high beta stocks. Those that display lower up-down price movements are described as low beta and are generally seen as lower risk.
High volatility doesn’t necessarily mean a stock should be avoided. It simply warns investors to expect large price swings one way or the other. Investors with heart conditions who watch stock prices closely should probably choose lower beta alternatives.
Recently, Kiplinger’s Personal Finance identified the top 20 high beta S&P 500 stocks, using data from the past 12 months. They included several well-known names such as Nvidia Corp., eBay Inc., PayPal Holdings Inc., Adobe Inc., Facebook parent Meta Platforms Inc. and Micron Technology Inc.
“Buy-and-hold investors probably shouldn’t try this at home, but active or tactical investors and traders might want to try adding some quality, high-volatility stocks to their holdings,” writer Dan Burrows said.
Although the article was written for a U.S. audience, Mr. Burrows’s advice applies to Canada as well, as least based on recent trends. Look at the S&P/TSX Composite Volatility – Highest Quintile Index. It tracks the performance of the 50 most volatile stocks in the index. As of April 12, the one-year gain was 5.8 per cent. But year-to-date, the gain is 7.6 per cent. In other words, all the upside over the past year occurred in the first 3½ months of 2022.
That’s a better performance than the S&P/TSX Composite Low Volatility Index, which is up only 1.4 per cent year-to-date. If you throw in another variable, the S&P/TSX Composite Low Volatility High Dividend Index is ahead 4.3 per cent this year. That still doesn’t match the performance of the leading high volatility stocks.
These numbers suggest that, despite all the talk of the shift from growth to value, growth stocks are still producing better returns. But here’s the problem: There is no exchange-traded fund that offers a portfolio of quality, high-volatility Canadian stocks.
There are some that are based on VIX, such as the Horizons S&P 500 VIX Short-Term Futures ETF (HUV-T). But do you really want to invest in a security that lost almost 72 per cent in 2021 and shows a 10-year average annual compound rate of return of negative 48.4 per cent? I think not. I looked at several other VIX-based ETFs. A couple were worse than the Horizons entry, one was better, but none were impressive.
The bottom line is that if you want a high volatility ETF, there is nothing off the shelf that I can recommend. You’d have to build your own.
Low-beta stocks are a completely different story. Most Canadian ETF companies offer at least one and sometimes several low volatility funds (sometimes called minimum volatility). Here’s one example from my Internet Wealth Builder recommended list.
BMO Low Volatility Canadian Equity ETF
Background: This ETF (ZLB-T) invests in a portfolio of large-cap Canadian stocks that have a low beta history, meaning they are less sensitive to broad market movements and, therefore, theoretically less risky. The portfolio is rebalanced in June and reconstituted in December.
Performance: The fund has been moving higher since the start of the year, reaching a high of $42.68 earlier this month. Over the past decade (to March 31), the average annual total return is almost 13 per cent. The ETF closed Monday at $41.87.
Portfolio: There are 47 positions in the portfolio, all Canadian companies. The portfolio is fairly evenly balanced, with Hydro One Ltd. (4.7 per cent), Franco-Nevada Corp. (3.9 per cent), Metro Inc. (3.4 per cent), Fortis Inc. (3.4 per cent) and Emera Inc. (3.4 per cent) being the largest holdings.
In terms of sector breakdown, 21.1 per cent is in financials (a significant underweight from the TSX Composite), 16 per cent in utilities (an overweight), and 12.2 per cent in consumer staples. There are no energy stocks, despite the fact it’s the second-largest sector in the S&P/TSX Composite.
Key metrics: The fund was launched in October, 2011, and has almost $3-billion in assets under management. That’s up $2.4-billion at the time of our last update in September, 2020. The management expense ratio is 0.39 per cent.
Distributions: The fund makes quarterly payments, which are currently running at 26 cents a unit ($1.04 a year). At that rate, the yield at the current price is 2.5 per cent.
Tax implications: In 2021, about 98 per cent of the distributions were treated as capital gains or eligible dividends, making this is a very tax-efficient fund.
Risk: BMO classifies it as low-medium. Although this is a low-volatility fund, it is not immune from stock market risk. However, this fund should hold up better than the broad market in a steep decline.
Conclusion: This ETF is well positioned for current market conditions and offers some downside protection in the event of a continued sell-off.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe
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