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Inside the Market Nervous about the markets? These low-volatility funds are worth considering

Investors are nervous, and they should be. Growth forecasts are being scaled back as the U.S.-China trade war drags on. The bond yield curve has inverted for the second time this year, a warning of trouble ahead. Now U.S. President Donald Trump is threatening to hit Mexico with escalating tariffs if its government doesn’t stop the northward migration of Central Americans.

Against that background, it’s no surprise that markets have been sliding for several weeks. Investors are again searching for safe havens.

Bonds, cash and gold are the traditional refuges. But if you want to retain stock-market exposure while reducing risk, consider moving some money into low-volatility (also called minimum-volatility) ETFs. There are a growing number to choose from. Here are two from BMO that I like and have recommended to readers of my Internet Wealth Builder newsletter.

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BMO Low Volatility Canadian Equity ETF (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 and therefore, theoretically, less risky. As a rule, low-volatility funds tend to underperform in bull markets but hold up better when stocks fall.

Performance: The fund is up about 15 per cent so far this year. Over the past five years, this ETF has generated an annual return of 11.2 per cent (to April 30).

Portfolio: There are 46 positions in the portfolio, all Canadian companies. The only holdings that exceed 3 per cent of assets are Fairfax Financial (3.7 per cent), Emera Inc. (3.5 per cent), and Intact Financial (3.4 per cent).

In terms of sector breakdown, 21.6 per cent is in financials (a significant underweight from the TSX Composite), 15.2 per cent in utilities (an overweight), and 12.2 per cent in consumer staples. Interestingly, only 1.5 per cent is in energy, which is the second-largest sector in the Composite.

Key metrics: The fund was launched in October, 2011, and has $1.4-billion in assets under management. The MER is 0.39 per cent.

Distributions: The fund makes quarterly payments, which are currently running at 21 cents per unit (84 cents per year). At that rate, the yield at the current price is 2.5 per cent. However, it could be higher than that by the time the year is over due to a capital gains distribution in December. Last year, the capital gains distribution was 18 cents, bringing the total payout for 2018 to 98 cents.

Tax implications: In 2018, about 70 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 24.5 per cent was classed as capital gains. So this is a very tax-efficient fund.

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Risk: Medium. Although this is a low-volatility fund, it is not immune from stock-market risk. However, it should hold up better than the broad market in a steep decline. On May 31, for example, the units gained three cents while the broad market was down.

Conclusion: This ETF should continue to move modestly higher and offers some downside protection in the event of a continued sell-off.

BMO Low Volatility International Equity Hedged to Canadian Dollar ETF (ZLD-T)

Background: This is the international equivalent of the Canadian Low-Volatility EFT described above. It focuses on stocks from developed countries outside North America. The fund invests in units of ZLI, a companion low-volatility fund that is unhedged. In this fund, foreign-currency exposure is hedged back into Canadian dollars, thereby eliminating one level of risk.

Performance: The fund has been somewhat choppy this year but has been moving higher recently, hitting a high of $24.84 in late April before pulling back. The three-year average annual compound rate of return to April 30 was just over 9 per cent.

Portfolio: ZLI, which is the underlying fund here, holds 100 stocks. Japan is the number one favourite, with about a 20 per cent position, followed by France (18.5 per cent), Hong Kong (11.9 per cent), and Germany (11.8 per cent).

The portfolio is well-balanced, with real estate the largest sector at 15.3 per cent followed by industrials (14.1 per cent), consumer staples (13 per cent), and utilities (12.5 per cent).

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Key metrics: The fund was launched in February, 2014, and has not attracted a lot of investor interest, with only $73.3-million in assets under management. The MER is 0.45 per cent.

Distributions: The fund makes quarterly payments, which are currently running at 14 cents per unit (56 cents per year), for a yield at of 2.3 per cent. There is also an additional capital-gains distribution in December, which last year amounted to an impressive $1.04 per unit. That brought the total distribution for 2018 to $1.56.

Tax implications: In 2018, about 60 per cent of the distributions were treated as capital gains, while most of the rest was taxable income. So, this fund has some tax advantages but not to the same degree as the Canadian entry.

Risk: I would rank this is somewhat higher risk than the Canadian fund, as international stocks have tended to be more volatile recently.

Conclusion: This ETF is a useful addition if you want some overseas exposure in your account.

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

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