Why This Low Volatility ETF Just Keeps Chugging Along

The PowerShares S&P 500 Low Volatility Portfolio (PowerShares Exchange-Traded Fund Trust II SPLV) is one of the exchange-traded funds credited with making low volatility investing available to the masses. It is one of the ETFs on the receiving end of ample adulation as the low volatility shines bright in 2016.

A basic premise of low volatility ETFs is that they should be less bad than their traditional rivals when markets sag – the rub being a fund such as SPLV will leave some returns on the table when equities soar. Living in the current market environment, SPLV and rival low volatility ETFs are showing what they are made of. SPLV is higher by 5.7 percent year-to-date, a performance that is better than quadruple the returns offered by the S&P 500.

Focus On SPLV

Over the past three years, SPLV has outpaced the S&P 500 by 70 basis points while being 90 basis points less volatile. Since coming to market in May 2011, SPLV is higher by nearly 87 percent compared to a gain of 67.5 percent for the S&P 500. SPLV's volatility over that stretch has been 12.7 percent, or nearly 300 basis points below that of the benchmark U.S. equity index.

Related Link: Evaluating Tracking Error Concerns And Low Volatility ETFs

SPLV's underlying index “targets the least-volatile 100 members of the S&P 500 and weights its holdings by the inverse of their volatilities so that the least-volatile stock receives the largest weighting in the portfolio. From its inception at the end of November 1990 through February 2016, the index's value and profitability tilts contributed about 71 and 95 basis points, respectively, to its annual return,” according to Morningstar.

Investors well-versed in defensive investing know that sectors such as consumer staples and utilities often trader at higher multiples than the broader market. Although utilities are not stretched on valuation relative to their historical norms, the sector still is not cheap. As for staples, that sector is looking pricey against the S&P 500.

Things Change: Allocations And Holdings

SPLV is not the utilities haven it once was. That sector is 13.8 percent eight of the ETF's weight, good for SPLV's fourth-largest sector allocation. However, consumer staples rank as SPLV's largest sector allocation at 22.4 percent. The ETF is not bereft of cyclical sectors as highlighted by a 16.5 percent weight to industrial names, but SPLV currently features no exposure to the energy sector. Energy is the only one of the 10 GICS groups not included in SPLV at the moment.

SPLV has no sector constraints, which has advantages and drawbacks.

“This can lead to large – and perhaps unintended – sector bets and large shifts in the portfolio over time, which could make it difficult to use this fund as a core holding. For example, the fund's weightings in the financial services, real estate, and utilities sectors changed considerably between the end of June 2015 and April 2016,” added Morningstar.