Eric Dutram: Volatility in the equity market in recent years resulted in investors becoming overly vigilant while constructing their portfolios. In an effort to provide security to investors against prevailing market precariousness, ETF issuers have expanded their product array by launching low volatility and high beta ETFs in the market.
In order to have a better understanding of the products one must know what volatility and beta of a stock/fund means. Volatility refers to historical variations in the price or total return of a stock while beta refers to the stock’s sensitivity compared to the overall market (Six Easy Ways To Target Low Volatility Stocks With ETFs).
Low volatility and high beta ETFs have been specially designed to address the changing moods of the market. Unlike traditional market capitalization weighted fund ETFs, these products provide weight to the stock on the basis of their volatility and beta. Attributable to this distinctive style of weighting holdings, these products have become all the more appealing and popular among investors especially in the current market environment.
The current market turbulence is a good time to pick low volatility and high beta ETFs. Such ETFs are most suitable for investors who have a directional view of the market and are looking for more strategic ways of investing. Volatility and beta weighted ETFs provide investors with an option to alter the risk level in their portfolio while still maintaining broad market exposure (Three Low Beta Sector ETFs).
How are these ETFs used?
The ETF space has provided investors with an option to play in both the bullish and bearish phases of the market. When bullish, the investor can take advantage of the rally by investing in high beta ETFs and increase returns. In a bearish market, the investor can look to scale back risk by putting money in low volatility ETFs instead.
Investors who are bullish on the market can add high beta ETFs in their portfolio thereby capitalizing on increasing trends. These high beta ETFs generally include those stocks which have a beta of more than 1. So when the market rallies, these stocks will rise faster than the market as high beta stocks are those stocks that exhibit more volatile returns compared to the market.
For instance, stock like Wyndham Worldwide (NYSE:WYN) which has a high beta of 2.96, had yielded a positive return of about 16.2% in a 52-week period when S&P 500 rose by almost 0.51%.
Conversely, investors who believe that the market will go down can reduce or minimize the risk by including low volatility ETFs in their portfolio. Low volatility ETFs work effectively in down markets as such ETFs include those stocks in the fund which tend to fall less. Low volatility ETFs have become very popular in times of uncertainty—like right now– as these are known to mitigate risks when the markets are subject to big swings.
The performance of a fund depends on the directional move of the overall market, the occurrence of which cannot be guaranteed. So if the market moves in the opposite direction, then the overall strategy may fail to deliver the desired results.
Also, the majority of the high-beta stocks belong to the cyclical sectors like construction, real estate, banking, and metals. These sectors are not only cyclical in nature but are also interest rate-sensitive. One negative aspect of the volatility ETFs is that when the market is in the bullish phase, these ETFs fetch just average returns.
Improvement in the ETF industry has shown the path for the building of products inclined towards the high beta and low volatility stocks. Investors seeking to play on this slice of the market should look for ETFs like SPHB, SPLV, HBTA and LVOL.
Below, we highlight these products in a little greater detail, offering up some of the factors which make these funds tick for investors looking to make a play on either high beta, or low volatility stocks in basket form:
PowerShares S&P 500 High Beta Portfolio (NYSEARCA:SPHB)
SPHB, launched in May 2011, is one of the pioneers of the factor-driven ETFs. This is an ETF that aims to provide an exposure to U.S. stocks which have exhibited high beta over the past 12 months.
The ETF has been designed to offer investors an option to strengthen their overall exposure against the volatile U.S. equity market. Investors who want to ride the rally may invest in this ETF.
Although the fund was launched only recently, it was quickly noticed by many investors thereby building an asset base of $58.4 million. SPHB provides exposure to 100 U.S. high beta stocks from the S&P 500.
Also, the expense appears to be reasonable at 25 basis points while volume is high at 309,800 (Guide to the 25 Cheapest ETFs).
In terms of the portfolio, the fund appears to be highly sector specific as almost 60% of the asset base is invested in the Financials and Energy sectors (Three Financial ETFs That Avoid Big Bank Stocks). The remaining 40% is divided among Information Technology, Consumer Discretionary, Industrials, Materials and Telecommunication Services.
The fund’s concentration level in the top 10 holdings is, however, low at 12.21%. Among individual holdings, Genworth Financial Inc. (NYSE:GNW) with a beta of 1.70 takes the top spot in the fund with 1.30% of asset invested while Alpha Natural Resources, Inc. (NYSE:ANR) and Bank of America Corporation (NYSE:BAC) with respective betas of 2.69 and 1.81 occupy the second and third positions.
Russell 1000 High Beta ETF (NYSEARCA:HBTA)
Russell 1000 High Beta ETF follows the same strategy of investing in high beta stocks but the there is one attribute which differentiates it from SPHB. SPHB takes historical beta into account i.e. beta over the past 12 months while HBTA provides exposure to those stocks that are predicted to have a high beta as determined by a screening and ranking methodology applied to the output of the Axioma U.S. Equity Medium Horizon Fundamental Factor Risk model.
The product was launched in the same month as SPHB but this ETF received less investor attention which resulted in an asset base of just $4.3 million, much lower than SPHB.
Despite an expense ratio of 5 basis points lesser than SPHB, the fund could not manage to strengthen its asset base. Total stock holdings stand at 113.
If we look at the portfolio holding pattern, this fund is free of sector-specific risk and appears to be diversified by industries. Producer durables gets the maximum share of the asset at 26.2% while technology and materials make up 19.4% and 16.8% of assets, respectively.
The common attribute between the two funds is that both are free of company-specific risks. The concentration level in the top 10 holdings of this fund is 20.6%. The Sherwin-Williams Company (NYSE:SHW) takes the top position in the fund.
The return from the fund over a period of 1 year is negative 10.2% while Russell 1000 yielded a negative return of 1.23%.
Russell 1000 Low Volatility ETF (NYSEARCA:LVOL)
While HBTA provides exposure to high beta ETFs, Russell 1000 Low Volatility ETF works more effectively in a bearish phase of the market when investors seek to minimize their risk while still maintaining domestic equity exposure. This ETF includes stocks with low volatility and seeks investment result that closely corresponds to the total return of the Russell-Axioma U.S. Large Cap Low Volatility Index.
The Index has been designed to deliver exposure to stocks with low volatility as determined by a screening and ranking methodology applied to the output of the Axioma U.S. Equity Medium Horizon Fundamental Factor Risk model.
In a scenario where markets are experiencing big swings, low volatility ETFs fulfill the requirements of investors who seek to limit their downside risk. Making use of the volatility in the market, the fund could manage to build an asset base of $65.1 million in just one year at a minimal charge of 10 basis points.
LVOL provides access to 105 securities in its basket and doesn’t allocate more than 2.12% to any one stock in particular. This suggests that the product is well diversified from an individual security perspective and is unlikely to face company-specific risk.
With regard to sector exposure, consumer staples takes the top spot at 19.4% of assets, followed by 16.6% in Utilities, 16.2% in Health Care, and a 11.9% allocation to Producer Durables (The Comprehensive Guide to Consumer Staples ETFs).
PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV)
SPLV, launched in May 2011, is an ETF that aims to provide an exposure to the U.S. stocks which have displayed low volatility over the past 12 months. The ETF has been designed to offer investors an option to lessen their risk against the volatile U.S. equity market.
Despite the relatively recent launch, it could manage to build a solid asset base of $1,758.2 million. SPLV provides exposure to 100 U.S. low volatility stocks from the S&P 500. Also, the expense appears to be reasonable at 25 basis points while volume is high at 900,000 shares.
In terms of portfolio holdings, the fund has 29.1% invested in Consumer Staples thereby holding the top position in the sector profile of SPLV. Among individual holdings, Southern Company (NYSE:SO) and Kimberly-Clark Corporation (NYSE:KMB) are the top two companies for investment. The fund’s year-to-date return stands at 4.16%.
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