By John Wasik
CHICAGO, April 9 During the financial market
turbulence of recent years, fund marketers have launched a
number of stock funds that boasted exceptionally low volatility.
They were the equivalent of sea-sickness pills for those who
still wanted to go on stock-market cruises.
Yet these exchange-traded funds (ETFs) make less sense when
the stock market is bullish. You may sacrifice returns and could
dampen volatility more effectively with other strategies. In a
sustained bull market - if you want to be invested in stocks at
all - you would be much better off in a broad-based, all-in
index fund than a low-volatility ETF.
To be sure, as risk-reduction vehicles, low-volatility ETFs
play it safer by investing in mature companies with steady cash
flows and solid dividends. They are less likely to be sold off
in a market rout such as the one experienced last year.
For example, ETFs such as the PowerShares S&P 500
Low-Volatility Portfolio focus on long-established
dividend payers in consumer products and utilities. Their
overall approach is to lower the risk in stock market investing
by lowering the volatility.
LAGGING THIS YEAR
This strategy may have softened the swells from the stormy
markets of last year, but it's coming up a laggard this year as
a recovering economy is propelling the general market.
According to the Leuthold Group, "during periods of buoyant
equity returns, the strategy fails to perform
How much does the low-volatility approach fall behind during
up markets? About 4.0 percent on average, Leuthold reported.
Indeed, despite a strong showing overall for stocks in the
first quarter - the Standard & Poor's 500 index was up almost 12
percent in total return year-to-date through April 5 - even one
of the best-performing low-volatility ETFs - the EGShares Low
Volatility Emerging Markets Dividend fund - rose only
That return trailed the broad-based Vanguard Total Stock
Market Index ETF by almost three percentage points
year-to-date through March 31, according to an analysis prepared
by Lipper, which is owned by Thomson Reuters.
That's not to say you should throw the baby out with the
bathwater. Leuthold also found that "during periods of increased
market uncertainty" as defined by the CBOE Volatility Index
(VIX) being up at least two points, low-volatility stocks
outperform an average 6.48 percent from 1990 through 2011. The
funds in the Lipper sample also had volatility measures as much
as a point lower than the whole market.
Dividends have always been a bulwark when the market
commences a selling frenzy of high-flyers in technology and
non-essential businesses. The low-volatility companies will
protect you somewhat against "deteriorating equity market
sentiment and normal to negative equity market returns,"
according to Leuthold.
If you want a low-volatility portfolio in general,
concentrate on companies that have long track records of
dividend growth in boring businesses such as consumer staples
and electrical power generation. Think corn flakes and power
Worthy considerations in the low-volatility camp include the
Russell 2000 Low Volatility fund, which focuses on
smaller companies and the iShares MSCI Emerging Markets Minimum
Volatility Index fund, which holds companies from
If you want to remain in U.S. stocks for the long haul,
consider a low-cost, total market index fund such as the
Fidelity Spartan Total Market Index Fund. At an annual
expense ratio of 0.10 percent, managers give you a sampling of
most of the U.S. stock market.
Still, a much more comprehensive approach to market risk
should be on your radar screen. If you want a buffer against
U.S. stocks, consider real estate investment trusts, bonds and
commodities. And if you own single companies - such as your
employer's - hedge that risk by either reducing your stake or
buying put options on those shares, which will pay you when they
decline in value.
No matter what you or pundits think stocks will do this
year, the market will always be volatile and you will be at risk
for losing money if you're invested in it. You'll need to
regularly ask yourself how much money you can afford to lose -
and adjust your portfolio accordingly. There's no sin if you
don't want or need to be in stocks now, so it may make more
sense to shift more assets into bonds or cash.
Disclosure: I don't own any of these funds.