Home>Video>2 Ways to Limit Volatility

2 Ways to Limit Volatility

Thu, 1 May 2014

These ETFs have different approaches to the same goal, but one of them is a better core holding for long-term investors.


Video Transcript

The Morningstar Minute is our quick take on investments, the market, economic indicators, and more. Join us every day for fresh insights from our analyst team.

Alex Bryan: Low-volatility strategies have gained popularity over the last couple of years. Academic research has shown that stocks with low volatility tend to outperform their more volatile counterparts. Researchers believe this is partially because investors face leverage constraints, and they tend to overweight riskier stocks in an attempt to boost their returns and neglect some more boring, steady-Eddie stocks, which may cause them to become undervalued relative to the risk.

There are two approaches that investors can take advantage of this low volatility effect with ETFs. One is offered by PowerShares and the other is offered by iShares. The PowerShares series of low-volatility funds attempt to create a low-volatility portfolio by targeting stocks that have low volatility and then weighting them by the inverse of their volatility, so that the least volatile stocks receive the greatest weightings in the portfolio. In contrast, iShares, they consider the correlations between stocks in addition to their volatilities.

To illustrate the differences between these two approaches, consider the case of a company that just makes umbrellas and a company that only make sunblock. Individually, these stocks may not have low volatility, so they maybe excluded from the PowerShares series of funds. However, when they're combined within a portfolio, the volatility of one may offset the others. They may reduce the portfolio's volatility. IShares might include these types of stocks.

In addition, the iShares funds impose a series of constraints in order to limit turnover and improve diversification. For example, these funds will anchor their sector weightings to a market-cap-weighted benchmark. As a result, these funds may be better core holdings for long-term investors because they preserve diversification to a greater extent than the PowerShares funds and they allow investors to take advantage of this low-volatility effect.

  1. Related Videos
  2. Related Articles
  1. How to Make the Most of Your 401(k)

    In this special presentation, get the answers to key questions about the quality of your plan, whether your savings are on track with your goals, how to allocate assets, and what to do with assets when you leave your job.

  2. Become a Better Index Investor

    Roundtable Report: Experts dig into the ETF versus index fund debate, active and passive strategies, fixed-income benchmarks, factor investing, and much more.

  3. Ready Your Portfolio for Retirement

    Morningstar's Christine Benz demonstrates how to make a bucket portfolio best work for you, touching on allocation, RMDs, other income sources, and more.

  4. Under the Hood of Multifactor Investing

    Morningstar's Alex Bryan reviews several funds that blend multiple factor-based strategies and discusses how investors might use such strategies in their portfolios.

  5. Bucket Portfolios for Retirement Income: Step by Step

    Morningstar's Christine Benz walks investors through the basics of setting up and maintaining a 'bucket' retirement portfolio, including some of her favorite funds for retirees.

  6. Lost in Translation: Emerging-Markets Dividend ETFs

    The screening processes for high-quality dividend payers may not be as effective in emerging markets.

  7. 7 Habits of Successful Investors

    Special presentation: Learn how 'cheaping out,' building in discipline, and other simple steps help successful investors get it done.

  8. Top Picks From Morningstar's Strategists

    Morningstar investment experts Russ Kinnel, Matt Coffina, Josh Peters, and Sam Lee answer viewer questions about the current market and the best opportunities in stocks , funds, and ETFs today.

©2017 Morningstar Advisor. All right reserved.