Fed-Induced Volatility Makes These ETFs Attractive

With investors thirsty for safe-haven assets this year, 10-year U.S. Treasury yields have plunged 23.5 percent to start. Also declining are wagers that the Federal Reserve can move forward with multiple, if any, interest rate increases this year.

The dithering, oft-criticized U.S. central bank is widely cited as a significant contributing factor behind increased equity market volatility. Increased volatility has been a boon for low volatility exchange traded funds, including one of the group's titans: The PowerShares S&P 500 Low Volatility Portfolio SPLV.

One way of looking at SPLV is that as a particular sector's volatility declines, it can take on a more prominent role in the ETF. Conversely, as another sector's volatility increases, its weight can be reduced in the fund. Likewise, a sector's volatility does not need to increase dramatically for its weight to be lowered in SPLV.

“Prior to the latest round of quantitative easing, there was about a two-year lag between changes in the fed funds rate and changes in equity volatility. More recently, the level of volatility has been driven more by the size of the Fed’s balance sheet than by the overnight fed funds rate,” said PowerShares in a recent note. 

SPLV is doing its job, part of which is to be less bad than traditional benchmarks during periods of elevated volatility. Over the past year the ETF is down just 1.2 percent compared to a nearly eight percent loss for the S&P 500. 

Low volatility stocks outperform their high beta counterparts during times of divergent global monetary policies. That is exactly what investors are dealing with as the Federal Reserve wants to raise rates, while the Bank of Japan, European Central Bank and others engage in easy monetary policies.

“Reduced expansion in the Fed’s balance sheet has also coincided with the outperformance of low volatility investment strategies. Note the highlighted blue sections, where volatility (in the form of the ratio of the S&P 500 Low Volatility Index to the broader market S&P 500 Index) spiked during periods of flat to declining bank reserve balances (reduced expansion in Fed balance sheet),” said PowerShares.

Investors are responding to SPLV's desirable traits as the ETF has added $72.4 million in new assets this year, good for sixth-best among all PowerShares ETFs. SPLV's mid- and small-cap counterparts, the PowerShares S&P MidCap Low Volatility Portfolio XMLV and the PowerShares S&P SmallCap Low Volatility Portfolio XSLV, rank among the issuer's top 13 asset-gathering ETFs year-to-date.