Low Volatility Small-Cap ETFs Show Their Advantages

Low volatility exchange traded funds, mainly the PowerShares S&P 500 Low Volatility Portfolio (NYSE:SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSE:USMV), have received plenty of attention this as investors are searching for ways to cope with increasingly volatile equity markets.

Rising equity market volatility has also been a drain on small caps and the corresponding ETFs, but investors can cope with lagging smaller stocks by availing themselves of the less bad opportunity set presented by the ETFs that are small-cap answers to the likes of SPLV and USMV. That includes the PowerShares S&P SmallCap Low Volatility Portfolio (NYSE:XSLV) and the SPDR Russell 2000 Low Volatility ETF (NYSE:SMLV).

Low Volatility

As their names imply, XSLV and SMLV are the low volatility answers to the widely followed S&P SmallCap 600 and the Russell 2000 indexes. Just as SPLV pulls the 100 S&P 500 members with lowest trailing 12-month volatility, XSLV does the same with 120 members of the S&P SmallCap 600 Index. SMLV, the State Street offering, follows the Russell 2000 Low Volatility Index. That ETF is home to 362 stocks.

With small caps lagging to the point of being abject disappointments this year, the name of the game for investors is finding less bad ideas within this cap spectrum. Fortunately, SMLV and XSLV have been notably less bad than their corresponding traditional benchmarks over the past 90 days.

Over that span, XSLV is down about 6.7 percent. Obviously, that is nothing to brag about, but that showing is 150 basis points better than the Russell 2000 over the same span. XSLV, the PowerShares fund, is down 3.8 percent over the past three months, or 300 basis points better (less bad) than the fall of the S&P SmallCap 600 during that time.

Trimming volatility with small caps often means trimming exposure to healthcare and technology names and that is what SMLV and XSLV do. The Russell 2000 allocates over a third of its weight to those sectors, SMLV's combined allocation to those sectors is just 11.4 percent. The S&P SmallCap 600's combined health care/technology weight is nearly 30 percent, but XSLV's combined allocation to those sectors is barely over 10 percent.

SMLV thus far remains smaller than XSLV in terms of asset size, with approximately $33 million in AUM, but this can all change quickly and we would expect it to as investors may likely look to Low Volatility Equity exposures in portfolios if the bull market has run its course. We note that both the technical charts of XSLV and SMLV are severely distorted in the short term due to artificially low prints that occurred one week ago last Monday on an abominable open for stocks, which skews the short term view here, said Street One Financial Vice President Paul Weisbruch in a note out earlier this week.

SMLV may be smaller, but its expense ratio is just 0.12 percent per year. XSLV charges a still fair 0.28 percent.