Equity Exchange-traded funds (ETFs), which have been traditionally seen as a lower risk investment relative to individual companies, have started to show volatility in many unexpected funds. The PowerShares S&P 500 Low Volatility portfolio fell by 3 percent on Friday, while the iShares Edge MSCI Min Vol USA ETF declined by 2.7 percent. The markets suffered a loss on Friday, which was the worst since the aftermath of the Brexit vote.
The negative performance was particularly worrisome for the low-volatility shares, as these funds are typically associated with less uncertainty, given their mature nature (high dividends and low growth profile). According to Pravit Chintawongvanich, head derivatives strategist at Macro Risk Advisors in New York, dividend payouts are the major feature for these funds given that value is normally derived from it. We quickly preview these two ETFs and discuss what market participants should consider from the ETF Heat Map database:
- SPLV – PowerShares S&P 500 Low Volatility
- USMV – iShares Edge MSCI Min Vol USA ETF
SPLV, a PowerShares product, is based on the S&P 500 Low Volatility Index, which consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months. It is broadly diversified given its top three holdings (comprised of Waste Management, Pepsi and AT&T) represent approximately 4% of the fund. It has a 30 day SEC yield of approximately 2.2%, an expense ratio of 0.25% and has returned approximately 10% YTD.
USMV, an iShares product, seeks to track the investment results of an index composed of U.S. equities that have lower volatility characteristics that the general market. It also is broadly diversified, with its top three holdings (comprised of Paychex, Procter & Gamble and AT&T) represent approximately 4% of the fund. It has a 30 day SEC yield of approximately 2.1%, an expense ratio of 0.15% and has returned approximately 10% YTD.
Investors seemed to be rattled by the rising bond yield given the possible interest rate hike on the cards in the upcoming September meeting of the Federal Reserve. There appears to be an inverse relationship between the index of low-volatility funds, and the bond yield, as dividends becomes less-competitive as bond payouts rise.
We believe that low volatility ETFS would underperform in the initial stages, given that they are interest rate sensitive. But we believe, the quarterly rebalancing will replace the interest rate sensitive companies with their counterparts. This may initially act as a good entry point for market participants looking to add to their position.