The stock market offers good profit potential, but many investors worry about the risk. They hear stories about market crashes and long declines, such as the one we experienced in 2022, and they fear having their life savings wiped out.
The financial industry, which is always sensitive to investor emotions, has come up with a product designed specifically for these nervous folks. They’re called low or minimum-volatility funds, and they’re structured to reduce the chances of heavy losses when markets tank.
They do this by focusing on low-beta stocks. These are securities that are less sensitive to the up-and-down gyrations of the market than other stocks – think of them as plateaus as compared to mountain peaks.
The theory is that these low-beta stocks will outperform when markets are falling but underperform in bull markets, thereby smoothing out the rough edges of stock movements.
Do they work? Based on the evidence to date, yes. These funds don’t eliminate stock market risk, but they contain it quite efficiently.
Here’s one example from the recommended list of my Internet Wealth Builder newsletter.
BMO Low Volatility Canadian Equity ETF
Ticker: ZLB-T
Background: This ETF invests in a portfolio of large-cap Canadian stocks that have a low-beta history, meaning they are less sensitive to broad market movements than other stocks and are therefore theoretically less risky. The portfolio is actively managed. It is rebalanced each June and reconstituted in December.
Performance: The fund has a respectable gain of 9.39 per cent in 2023. The 10-year average annual compound rate of return is 10.32 per cent.
Key metrics: The fund was launched in October, 2011, and has $3.3-billion in assets under management. The MER is 0.39 per cent.
Portfolio: There are 49 positions in this equal-weight portfolio, all Canadian companies. Three grocery giants are in the top five: Loblaw (4.05 per cent of assets), Metro (3.87 per cent) and Empire (3.28 per cent). Other top five positions are Hydro One (3.57 per cent) and Thomson Reuters (3.2 per cent).
In terms of sector breakdown, 19.36 per cent is in financials (a significant underweight from the S&P/TSX Composite Index), 16.09 per cent in consumer staples and 14.58 per cent in utilities. Energy, which is the second-largest sector in the composite, has negligible representation.
Distributions: The fund pays quarterly cash distributions, which are currently running at 28 cents per unit ($1.12 per year). At that rate, the yield at the current price is 2.6 per cent.
Tax implications: The tax report for 2023 is not yet available. In 2022, about 59 per cent of the distributions were treated as eligible dividends, meaning they qualified for the dividend tax credit if held in a non-registered account. Another 39 per cent were classed as capital gains. So, this is a very tax-efficient fund.
Risk: This is the big selling point for this ETF. Over the past decade, it has been down in only two calendar years, and both times the declines were minimal. The worst was a drop of 2.83 per cent in 2018. In 2022, which was a terrible year for stocks, this fund lost only a fractional 0.37 per cent.
Conclusion: This ETF has a proven history of downside protection during stock market sell-offs. It will likely underperform during bull markets, but its long-term record shows it’s a good choice for conservative investors.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.
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Gordon Pape