Sticking With Low Volatility As Rates Rise

It's often said that low volatility exchange-traded funds are vulnerable to rising interest rates. That much is being confirmed this year as the S&P 500 Low Volatility Index is slightly lower while the traditional S&P 500 is up 4.4 percent.

For low volatility investors, there's some good news in the form of the Invesco S&P 500 ex-Rate Sensitive Low Volatility ETF XRLV. True to its name, XRLV has been significantly less sensitive to rising interest rates as highlighted by its year-to-date gain of 3.1 percent.

What Happened

XRLV, which recently celebrated its third birthday, follows the S&P 500 Low Volatility Rate Response Index. That benchmark is home to 100 S&P 500 members with low volatility traits and low interest rate risk.

The index “is designed to include stocks exhibiting low volatility characteristics, after removing stocks that historically have performed poorly in rising interest rate environments,” according to Invesco.

Why It's Important

Historical data suggest the low volatility low rate risk index offers the potential for out-performance of traditional equity benchmarks.

“Over the longer time horizons, the low volatility and rate response indices outperformed the S&P 500, with lower volatility,” said S&P Dow Jones Indices in a recent note. “In fact, the rate response index performed better than both the low volatility index and the S&P 500 for all measured periods. The rate response index was slightly more volatile than the low volatility index—nevertheless, it had a cumulative risk reduction of 19.3 percent relative to the S&P 500 (the low volatility index had a risk reduction of 23 percent).”

XRLV doesn't abandon cyclical fare in its efforts to reduce volatility. Over 24 percent of the fund's holdings are classified as growth stocks.

What's Next

XRLV's mettle will be tested if the Federal Reserve, as expected, proceeds with more rate hikes before the end of the year.

“We have seen that the rate response index has been able to perform better than the low volatility index in periods of rising interest rates, while also retaining the volatility reduction characteristics of a low volatility strategy,” said S&P Dow Jones.

XRLV features no exposure to utilities stocks and low allocations to consumer staples and real estate names, sectors that are often prominent low volatility strategies. Financials and industrials combine for over 42 percent of the fund's weight.

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