Lower Risk with These 3 Smart Beta ETFs

The global stock market can be a bumpy place and it seems these days that bumpiness is coming more often than not. It seems that investors have been on edge since the end of the Great Recession. Central bank policies, poor earnings reports, debt concerns, lower economic growth, among other drivers, can cause the markets to swoon, and today, volatility is reigning supreme.

And while time in the market heals all wounds, it can’t cover up all volatility issues. When it comes to performance and returns, portfolios that exhibit higher volatility and experience higher highs and lower lows can actually see lower total returns than ones that jump around less. That has to do with compounding and the loss of investment capital during the bigger downtrends. The smoother the ride your portfolio takes, the better off you’ll actually be.

For straight broad index investors that fact may not provide them with much comfort. But luckily, today’s portfolios have plenty of tools to smooth volatility and lower investment risk. The latest trend of smart beta ETFs, or those that use factors to determine their portfolios, have created funds that promise to de-risk a portfolio and reduce its volatility.

Here are three of the more interesting choices.

Perhaps the easiest route to lower a portfolio’s overall volatility and risk is to eliminate all of those stocks that show tendencies for high volatility. The PowerShares S&P 500 Low Volatility ETF (SPLV A+) does just that.

SPLV tracks the S&P 500 Low Volatility Index. This index consists of the 100 stocks from the bread-and-butter S&P 500 that exhibit the lowest realized volatility over the past 12 months. Basically, the ETF will screen for those stocks whose magnitude of up and down asset price “jumps” are the lowest in the index. This helps minimize the peaks and valleys of SPLV’s performance which in turn reduces losses during market declines and provides some gains when things rise. It also throws off some hefty income and dividends as well. Typically, low volatility stocks tend to be those that pay steady dividends across long stretches of time.

And SPLV’s simple strategy of removing the “bag eggs” seems to work well. During the recent maelstrom caused by China and the Fed’s pending rate hike, SPLV declined by only 5%. That was about 1% better than the broad S&P 500.

The expense ratio for the $4.7 billion ETF runs a cheap 0.25%, or about $25 per $10,000 invested. That’s lower than some regular index funds. At that cheap price, there’s no reason not to protect against volatility.

While the previously mentioned SPLV removes stocks that exhibit high volatility, the Janus Velocity Volatility Hedged Large Cap ETF (SPXH ) takes a different approach. SPXH hedges its volatility risk away with various futures contracts.

SPXH tracks the VelocityShares Volatility Hedged Large Cap Index. This index will go long on the S&P 500 as well as long and short in short-term VIX futures. The ETF will target equity exposure of 85% to the S&P 500 by using other liquid ETFs: the Vanguard S&P 500 ETF (VOO A), the iShares Core S&P 500 ETF (IVV A) and the SPDR S&P 500 ETF (SPY A). The remaining 15% is divided up between volatility futures via swaps.

The idea is that SPXH’s shifting volatility strategy will help prevent massive drawdowns during periods of stress as the futures will rise. That strategy seems to be working just fine. During the last month when the markets got rocky and volatility futures surged, SPXH lost only 3.2%. This was about half of the S&P 500 index’s return.

And while SPXH’s 0.71% in expenses may seem high, it’s still a lot cheaper than trying to hedge your own portfolio using futures. All in all, the ETF could be a great tool for investors looking to lower their volatility.

For investors looking for a complex and more active solution to reducing volatility risk, the Barclays ETN+ S&P VEQTOR ETN (VQT C) could be the one.

VQT tracks the S&P 500 Dynamic VEQTOR Total Return Index. The mouthful of an index provides a unique take on volatility. The exchange-traded note (ETN) will cycle through equity, volatility, and cash investments as volatility increases or decreases. In times of low volatility, it will increase its exposure to equities. When volatility rises, it’ll buy volatility futures, and when equities drop 2% or more in the preceding five days, it’ll move to cash. The fund uses futures, S&P 500 Total Return, and Short-Term VIX, to gain its equity and volatility exposure.

All in all, the ETN provides a real hedge for investors as it has the ability to hold more cash when the market gets crazy, potentially preventing some big losses. Meanwhile, if things are normal or just sort of crazy, exposure to stocks and volatility futures will provide profit potential.

And it’s easy to see why VQT has quietly amassed around $425 million in assets since its launch. The shifting strategy works. During August’s recent market rout, the ETN lost just under 2%. That sort of downside protection makes the ETN’s 0.95% expense ratio potentially worth it for investors looking to really reduce their risk.

If there has been one constant since the end of the Great Recession, it’s that volatility continues to plague the markets. That can be a huge problem as the market phenomenon can cause lower total returns over the long haul. Luckily, there are plenty of ways investors can reduce their exposure to threats. The Barclays ETN+ S&P VEQTOR ETN (VQT C), the Janus Velocity Volatility Hedged Large Cap ETF (SPXH ), and the PowerShares S&P 500 Low Volatility ETF (SPLV A+) are some of the most promising options.

Disclosure: None

Image courtesy of hywards at FreeDigitalPhotos.net