Low Volatility Is Absolutely Crushing High Beta

It might be heresy to say, even unrealistic to comprehend, particularly in a year in which investors have heard so much about the growth and momentum factors trumping value, but the stark reality is low volatility exchange traded funds are crushing their high beta counterparts.

Technical analysts and assorted other market experts like to gauge the low volatility vs. high beta match-up with a ratio analysis of the PowerShares S&P 500 Low Volatility Portfolio SPLV and the PowerShares S&P 500 High Beta Portfolio SPHB.

Year-to-date, SPLV is up 2.4 percent, which on its own is not awe-inspiring, but it looks gorgeous relative to the 5.1 percent lost by SPHB. SPLV's advantage over its high beta counterpart has accelerated in the current quarter. Since July 1, SPLV is up 3.2 percent while SPHB is lower by 3.8 percent. None of this is a condemnation of SPHB. The ETF was working pretty well earlier this year. Rather, these data points underscore the advantages offered by less volatile fare in the current market environment.

What is interesting is how SPLV, which just happens to pay a monthly dividend, is arriving at this substantial outperformance of SPHB. Remember the days when naysayers nagged SPLV for being a utilities ETF in disguise? Those days are long gone because utilities are just 2.77 percent of SPLV's weight. Only two sectors command smaller weights within the ETF.

In what may be a surprise to some investors, financial services is by far the larges sector weight in SPLV at nearly 36 percent. It is not that utilities have gotten exceptionally volatile. Data suggest that even during the most recent surge in Treasury yields, rate-sensitive utilities were only modestly more volatile than historic averages.

What has happened is that financial services volatility has waned to the point that nearly 36 of the 100 S&P 500 stocks that comprise SPLV's portfolio hail from that sector. Interestingly, nearly a third of SPLV's financial holdings are rate-sensitive real estate investment trusts (REITs), but the ETF balances that out with nearly all of its remaining financial holdings being banks and insurance providers. Those groups are perceived to be positively levered to rising interest rates.

SPHB is not bereft of financial services exposure. The sector is 15.2 percent of the high beta ETF's weight. SPHB's largest sector allocation is 18.7 percent to industrials, a group SPLV has a 13.8 percent weight to. Among several, the most obvious sector discrepancy between the two ETFs is SPHB's 18.6 percent weight to energy stocks compared to zero percent in SPLV.

It does not take an expert in ratio analysis to determine that at a time when energy is the worst-performing sector in the S&P 500, SPLV's outperformance of SPHB is being driven as much by what the former does not include as what it does.