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According to traditional finance theories—investors demand a higher rate of return for taking greater risks but some of recent empirical studies show that the lower risk stocks have rewarded the investors with higher return than the broader markets over longer-term.

This “low risk anomaly” may be due to “mispricing” of risk by the market or in simple words, it may be a result of too many investors chasing higher risk stocks in anticipation of higher returns and in turn paying too much for such stocks. (Read: 3 Excellent ETFs for Income Investors)

Though the low-volatility concept is relatively new in the ETF universe, it has become extremely popular of late. Low-volatility ETFs pick stocks based on their historical price volatility.

S&P 500 Low Volatility ETF (SPLV - ETF report) was the first product in this space and is so far the most popular, with more than $3.4 billion in assets. It is one of the most successful launches in ETF history.

A series of new low-volatility or minimum volatility ETFs have been launched after SPLV to capitalize on soaring investor interest in this strategy. Four new products were launched this month, expanding the line-up to 12 products in the US. Investors seeking to ride out frequent bouts of volatility in the markets have continued to pour money into these funds.

We have little historical data available for these ETFs but they have outperformed their broader market counterparts since inception. These ETFs effectively protected the downside during market turmoil but they underperformed when the trend was strongly bullish. (Read: Best ETF Strategies for 2013)

For longer-term performance, we looked at the historical data for the indexes that these ETFs track. The table shows annualized returns and standard deviations calculated using monthly index return data for the past five years for the low-volatility indexes and the respective regular indexes.

 

Index (ETF)

Annualized Return (5 Y)

Annualized Std.Dev. (5 Y)

U.S.

S&P 500 Low Volatility Index TR (SPLV - ETF report)

9.45%

12.60%

S&P 500 TR Index

6.47%

19.03%

All-World

MSCI All Country World Minimum Volatility Index  (ACWV - ETF report)

2.22%

15.80%

MSCI All Country World Index

1.92%

23.65%

Emerging Markets

MSCI Emerging Market Minimum Volatility Index (EEMV - ETF report)

6.76%

22.32%

MSCI Emerging Markets Index

2.35%

28.47%

The results (the table above and the following charts) show that the low volatility strategies handily beat the broader markets with significantly less volatility, in the U.S., international and emerging stock markets in the last five years.

While it is true that the markets were in general more volatile during the past five years, we can reasonably expect that going forward the level of volatility in the markets will stay at elevated levels at least in the foreseeable future.

Academic studies suggest that market volatility over extended periods of time is driven by macroeconomic environment.  Given extraordinary global macroeconomic conditions and unconventional monetary tools employed by the central banks all over the world, market volatility will continue to be high. (Read: Treasury Bond ETFs-Still Room to run)

Further, per S&P Indices, backtesting of the index over past 20 years revealed that:

·         S&P 500 Low Volatility Index was less volatile than the parent S&P 500--24% volatility reduction over 20 years and 32% volatility reduction over most recent 10 years.

·         Lower volatility did not mean lower returns as S&P 500 Low Volatility Index outperformed the S&P 500 for the 20 year period and in 9 of the 20 years between 1991 and 2010.

Another study analyzed the stock returns from 1968 through 2008 and found similar results.

Based on the above, I think that we can safely infer that low-volatility stocks and ETFs are very attractive investments for longer-term investors who focus on risk-adjusted returns.

PowerShares S&P 500 Low Volatility ETF (SPLV - ETF report)

SPLV tracks the S&P 500 Low Volatility Index, which consists of 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months.

ETF currently has an attractive 12-month yield of 2.83%, while it charges an expense ratio of 0.25% per year.

The ETF holds 100 securities currently, mostly from the Consumer Staples (24%), Utilities (31%) and Financials (15%) sectors. The ETF has returned 7.53% year-to-date. It is a Zacks #1 (Strong Buy) ETF.

iShares MSCI All Country World Minimum Volatility Index Fund (ACWV - ETF report)

ACWV is ideal for investors looking for low-volatility product with global exposure. It tracks MSCI All Country World Minimum Volatility Index, which is a capitalization weighted index of securities in the developed and emerging economies that have lower absolute volatility. The weight of the stocks in the index is determined by a rules based methodology.

The ETF holds 264 securities which are mainly from the Consumer Staples (15%), Healthcare (15%) and Financials (16%) sectors.

ACWV has an expense ratio of 0.35% and a 12-month yield of 1.83% currently. The fund invests about 51% of its assets in US securities while Japan (12%) and Canada (8%) occupy the next two spots in terms of country exposure.

The fundt has returned 6.76% year-to-date.

iShares MSCI Emerging Market Minimum Volatility Index (EEMV - ETF report)

EEMV is an ideal choice for the investors looking to participate in the emerging markets growth while limiting their portfolio volatility.

The ETF holds 213 securities from the Financials (27%), Consumer Staples (13%) and Telecom (12%) sectors. Taiwan (16%). China (14%) and South Korea (10%) are the top countries in terms of exposure.

The fund charges a low expense ratio of 25 basis points while the 12-month is 1.64%. It is a Zacks #2 (Buy) ETF.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Dayslick to get this free report >>

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