Low Volatility ETFs Could Be Hot In 2016

If 2015 has been a volatile year for stocks, then low volatility exchange-traded funds have strutted their stuff. While the S&P 500 is up just 1.6 percent year-to-date, the PowerShares S&P 500 Low Volatility Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE:SPLV)) and the iShares MSCI USA Minimum Volatility ETF (iShares Trust (NYSE:USMV)) are up an average of 3.7 percent.

Investors should expect more of the same next year, and it looks like they are already prepared as highlighted by the more than $3 billion in new assets that have flowed into USMV.

The Appeal

Investors should brace for larger market fluctuations by choosing low volatility stocks rather than those of companies that are more market sensitive, said Chad Morganlander, portfolio manager at Stifel Nicolaus Washington Crossing Advisors, reported Yahoo Finance.

Morganlander told Yahoo Finance that low volatility stocks outperform their high beta counterparts during times of divergent global monetary policies. That is exactly what investors are dealing with as the Federal Reserve ebbs closer to its first interest rate hike in nine years, while the Bank of Japan, European Central Bank and others engage in easy monetary policies.

Low Volatility And High Beta

The theory that low volatility outperforms high beta in such environments has been highly supported this year.

For example, SPLV is higher by 3 percent on the year, while the PowerShares S&P 500 High Beta Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE:SPHB)) has slumped 11.3 percent.

Looking Into SPLV

SPLV holds the 100 S&P 500 members that are the least volatile on a 12-month basis. No stock accounts for more than 1.25 percent of the ETF's weight. Top 10 holdings include Clorox Co (NYSE:CLX), The Coca-Cola Co (NYSE:KO) and Procter & Gamble Co (NYSE:PG).

Since inception, SPLV's underlying index has outpaced the S&P 500 by more than 100 basis points.

Other Low Volatility ETFs

The potential leadership of low volatility stocks in 2016 probably will not be limited to the primarily large-cap lineups found in SPLV and USMV. Investors might want to give a nod to low volatility mid- and small-cap ETFs as well.

The PowerShares S&P MidCap Low Volatility Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE:XMLV)), which takes the 80 least volatile stocks on a trailing 12-month basis from the S&P MidCap 400 Index, has enjoyed a banner year. XMLV is up 4.5 percent, while the S&P MidCap 400 Index is down 1.7 percent.

Critical View Of Low Volatility

Critics of low volatility ETFs say that long-term investors must endure sub-par returns relative to the traditionally weighted benchmark in exchange for the reduction in volatility.

However, XMLV's underlying index has lagged the S&P MidCap 400 by just 26 basis points since inception, according to PowerShares data.

Small-Cap Equivalent

SPLV and XMLV have a small-cap equivalent, the PowerShares S&P SmallCap Low Volatility Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE:XSLV)).

XSLV, which takes the 120 least volatile stocks on a trailing 12-month basis from the S&P SmallCap 600 Index, is up 2.2 percent year-to-date while the S&P SmallCap 600 Index is off 1.1 percent.

XSLV allocates 54.4 percent of its weight to financial services stocks and 16.2 percent to industrials. Just 12.2 percent of the ETF's holdings are considered growth stocks.

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