Low-Volatility ETFs Ready for Next Act

One of the most popular ETFs launched in the past couple years is PowerShares S&P 500 Low Volatility Portfolio SPLV, and it's not hard to guess why. After suffering through the dot-com crash and 2008 financial crisis, investors are putting a premium on safety, particularly when dipping their toes into stocks. In the last five years, investors have pulled $548 billion from U.S. equity mutual funds and plowed more than $1 trillion into taxable fixed-income funds, according to ConverEx Group. However, equity-based ETFs have gathered $330 billion of inflows during the same period. Recently, a decent chunk of these ETF flows has been earmarked to “safer” funds that employ low-volatility and dividend strategies with indexes. For example, SPLV has quickly grown to over $3 billion in assets after launching in May 2011. The fund is one of the biggest success stories in ETFs the past few years, and investors can expect more low-volatility funds to hit the market in 2013. The ETF's tracking index is comprised of the 100 stocks from the S&P 500 with the lowest realized volatility the past year. Volatility is a measure of a security's tendency to jump around in price. SPLV has been popular because the strategy is relatively easy to explain and understand, and investors want some downside protection when venturing into stocks. The fund turned in a respectable 2012 with a 10.1% total return but it did trail the S&P 500, which gained 16%, according to Morningstar. “Naturally, with a low-volatility bent, the fund emphasizes defensive sectors such as utilities and consumer staples,” the investment researcher says in a profile of SPLV. The fund's underperformance relative to the S&P 500 can be attributed partly to the overweight in these two sectors. Utilities Select Sector SPDR XLU rose just 1 percent last year, while Consumer Staples Select Sector SPDR XLP added 10.7 percent. SPLV has 31 percent in the utilities sector and 26.8 percent in consumer staples, according to manager Invesco PowerShares. Low-volatility strategies have historically earned “excellent risk-adjusted returns” but can “perform miserably during furious bear markets,” Morningstar notes. Now, Invesco PowerShares is readying a pair of funds in an attempt to capitalize on the success of SPLV. According to a recent filing, the firm wants to launch PowerShares S&P 400 Low Volatility Portfolio and PowerShares S&P 600 Low Volatility Portfolio, which would track the mid-cap and small-cap portions of the U.S. stock market, respectively. Other existing ETFs on the market designed to track low-volatility benchmarks include:

• iShares MSCI Emerging Markets Minimum Volatility Index Fund EEMV
• iShares MSCI All Country World Minimum Volatility Index Fund ACWV
• iShares MSCI USA Minimum Volatility Index Fund USMV
• PowerShares S&P International Developed Low Volatility IDLV
• PowerShares S&P Emerging Markets Low Volatility Portfolio EELV
• iShares MSCI EAFE Minimum Volatility Index Fund EFAV
• EGShares Low Volatility Emerging Markets Dividend ETF HILO