Can Low Volatility ETFs Safeguard Gains?

Wall Street’s popular measure of expected volatility in the stock market recorded its largest-ever intraday jump on Monday. The Cboe Volatility Index’s (VIX) spike marks a significant shift in market sentiment and could be an indicator that the unusually long-period of market calm is over.

The VIX reached 65.73 before market open on Monday. This marked the third-highest level recorded since 1992, and a 42-point increase from Friday’s close. However, by market close on Monday, the VIX had fallen to 38.57. Despite this being the highest close since October 2020, the significant difference between the intraday high and the close notched a record.

The VIX’s sharp rise underscores growing concerns regarding the global economy. On Monday, markets reacted to a rate hike from the Bank of Japan, an unwinding in the yen carry trade, as well as growing U.S. recession fears due to a failure to cut rates by the Fed and weaker-than-expected U.S. employment data

Furthermore, with the presidential election just a few months away, it may be prudent to anticipate uncertainty and volatility in markets will continue. Investors may consider positioning portfolios more defensively in response to the shifting economic environment and increasing uncertainty.

“The recent market volatility has many people reassessing their equity exposure,” said Todd Rosenbluth, head of research at VettaFi. “There are some strong ETFs that own the historically least-risky stocks. Time in the market is better than timing the market.”

The economic outlook for the duration of 2024 and beyond remains uncertain. Many investors are mindful of the strong market gains in 2023 and 2024, but have concerns about the near-term future. This is where low volatility ETFs can potentially serve as a solution.

Low volatility ETFs can keep help investors maintain target equity exposure during choppy markets. Low volatility ETFs generally hold less-risky stocks, which might not climb as high if gains continue, but can provide protection if a pullback occurs. This is how low volatility ETFs can effectively minimize downside risk.

A few funds to consider include the Invesco S&P 500 Low Volatility ETF (SPLV A+), the iShares MSCI USA Min Vol Factor ETF (USMV A+), and the Fidelity Low Volatility Factor ETF (FDLO B+).

Between July 31 and August 5, the S&P 500 fell more than 6%. The four low volatility ETFs outperformed the S&P 500 during this period, with SPLV most effectively limiting losses (declining just 1.4%). SPLV was trailed by LGLV, USMV, and FDLO, which fell 1.8%, 2.4%, and 3.7%, respectively.

Low volatility ETFs’ ability to mitigate losses is better demonstrated over a one-month period. As tech stocks slumped in July and investors rotated into small-caps, low volatility ETFs held up better than the S&P 500. Again, all four low volatility ETFs — SPLV, LGLV, USMV, and FDLO — outpaced the benchmark during the one month trailing August 5.

It’s worth highlighting that low volatility ETFs and the S&P 500 are now boasting similar year-to-date total returns. While the S&P 500 was handily outpacing low volatility ETFs during the first half of 2024, the index’s recent decline has brought its year-to-date total return to 9.6% as of August 5.

The S&P 500 has given up gains to the point it is now trailing USMV, right on par with LGLV, year to date through August 5. While SPLV and FDLO are still lagging the S&P 500 by a modest margin year to date, more market volatility could shift performance in the low volatility ETFs’ favor.

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