With recent concerns that summer won’t be so docile and that market volatility could creep higher, exchange traded funds like the Invesco S&P 500 Low Volatility ETF (SPLV ) are getting renewed attention.
But investors should look under the hood and understand how the mechanics of low volatility ETFs drive performance. Since the coronavirus market swoon in 2020, low volatility ETFs have lagged the broader market, but that’s often the cost of admission for less turbulent market exposure: more muted returns when stocks soar.
“Over the long run, low-volatility strategies have proved effective at cutting back on statistical measures of risk,” writes Morningstar analyst Daniel Sotiroff. “But they differ from many other strategies in that they aren’t designed to beat the market. Instead, the expectation is marketlike total returns with less risk, which sets them up for better risk-adjusted performance. Cutting back on risk may make them an easier stock strategy to stick with, but they come with trade-offs and are by no means a substitute for cash or bonds.”
Low Vol ETFs: Doing Their Jobs
With low volatility ETFs like SPLV, it’s vital that investors realize this is a long-term strategy, one designed to smooth out market gyrations over long holdings periods.
For example, from January 2012 through May 2021, SPLV’s average annualized volatility was well below that of the S&P 500, as was the SPLV average drawdown.
However, the rub was that ETF lagged the S&P 500 by almost 400 basis points on an annualized basis, although returns were still solid for the low volatility fund.
“Low-volatility ETFs hummed along as expected for years leading up to the coronavirus pandemic. Periods of outperformance aligned with market dips, while lackluster returns were tethered to strong rallies,” adds Sotiroff.
At the end of the day, investors should expect low volatility ETFs to smooth out bumps over long holding periods, but they should not expect market-beating or even matching returns.
“These strategies should continue to eliminate a decent chunk of risk from the market without sacrificing too much return. Investors will have to deal with lagging when the market is doing well. That’s the price for cutting back on risk,” concludes Sotiroff.
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