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Can Low Volatility ETFs Beat Bonds for Portfolio Stability?

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Hedging market risks with low volatility ETFs is in vogue. Low-volatility ETFs give exposure to the equity market but accompany lesser risk. The products have lately attained immense popularity as evident by the stellar 20.2% returns offered by PowerShares S&P 500 Low Volatility ETF SPLV in the last two years (as of August 22, 2016) compared with the plain S&P 500 ETF SPY’ s 9.2%.

The propensity to park money in low volatility stocks normally rises when volatility levels are high. This made these investments highly coveted in the Brexit aftermath. Plus, uncertainty regarding Fed tightening, global market turmoil amid growth issues and geo-political concerns made low volatility ETFs clear winners a few days back.

Investors believe low volatility ETFs tend to lower risk and generate decent returns, while ETFs with higher beta stocks face acute losses. Forget about dark days, these low volatile products often accumulate considerable assets even in bull markets.

SPLV added about $568.8 million in assets since the start of Q3 when SPY gathered about $12.9 billion. Notably, these performances came in a bull market when SPY rose about 4.3% (as of August 19, 2016), meaning investors are hooked on low volatile products (read: Low Volatility ETFs in Vogue Despite a Bull Market).

But Are These Really That Low Volatile?

Probably not. Agreed, these low volatile products go a long way in protecting investors’ wealth in a bear market but bonds do a better job normally. In the last five years (as of August 22, 2016), SPY surged 85.4% while SPLV added 78.5%.

As per Wall Street Journal, the father of the low-volatility investment strategy Robert Haugen said that low-volatility stocks are no “substitutes for bonds.” At the end of the day, low volatility equities are also equities – a risk-on asset class, may be with just a little less risk.

Wall Street Journal’s article noted that “the top 25 holdings of iShares Edge MSCI Minimum Volatility USA (USMV) have an average star rating of 2.7 from Morningstar,” which indicates an expensive valuation as per Morningstar’s specified norm. Also, P/E ratios of low volatility ETFs like USMV, XMLV andXSLV are 24.8, 22.1 and 20.3, respectively. On the other hand, the P/E for SPY is 17.08 times, pointing to overvaluation concerns.

Why are Bonds Better Bets?

When the broader market turns turbulent, it is better to put money into safe-haven assets like Treasury bond ETFs. The Wall Street report says that “core bond portfolios have produced standard deviations of returns of around 4% for the past quarter-century. That means their returns have mostly fallen in a range of 4% from their average return.”

iShares 7-10 Year Treasury Bond IEF has a five-year standard deviation of 5.51%, SPLV has 9.33% and SPY has 12.06%. The figures clearly show the volatility quotient of each product. Notably, the lower the standard deviation, the lesser is the volatility (read: Which Low Volatility ETFs Will Protect Your Portfolio?).

This year, especially the first half, has been fraught with worries related to the Chinese market slowdown, oil price plunge and Brexit. So, risk-off sentiments are prevalent (read: Top ETF Stories of the First Half of 2016).

In such a scenario, we have profiled four top-performing low volatility and U.S. Treasury bond ETFs, in which treasuries clearly outdid low-volatile products (read: Brexit Fuels a Global Rally in Bond ETFs).

Low Volatility ETFsYTD Return (as of August 22, 2016)Treasury Bond ETFsYTD Return (as of August 22, 2016)
PowerShares S&P MidCap Low Volatility Portfolio ETF XMLV16.3%PIMCO 25+ Year Zero Coupon U.S. Treasury Index Exchange-Traded Fund ZROZ27.0%
The Legg Mason Low Volatility High Dividend ETF LVHD15.6%Vanguard Extended Duration Treasury ETF EDV25.8%
PowerShares S&P SmallCap Low Volatility Portfolio ETF XSLV15.4%

iShares 20+ Year Treasury Bond ETF TLT

Victory CEMP US Large Cap High Dividend Volatility Wtd Index ETF CDL14.7%Vanguard Long-Term Government Bond ETF (VGLT - Free Report) 16.2%

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