Skip to Content
ETF Specialist

A Defensive-Stock Fund for Risk-Averse Investors

Low-volatility funds offer lower risk but not necessarily better returns than the market.

Mentioned: , , , , , , ,

Low-volatility equity strategies were all the rage two years ago. Investors were looking to tiptoe back into the equity market but could not stomach the volatility, and two newly minted exchange-traded funds were happy to meet the demand.  IShares MSCI USA Minimum Volatility (USMV) and  PowerShares S&P 500 Low Volatility (SPLV) raked in $6 billion in the year through April 2013. Those strong flows came at a time when overall demand for equities was tepid. The organic growth rate for large-blend funds was only about 2% during that period. Since that time, the broad equity market has rallied, and investors have pulled $3 billion out of the low-volatility funds while ramping up investment in the broader equity market. While these funds should lag during bull markets, they may pay off during market downturns. Investors who try to chase performance are likely to be disappointed.

USMV is a suitable core holding for conservative investors who want exposure to stocks with less volatility than a traditional stock portfolio. It attempts to construct the least volatile portfolio using stocks from the MSCI USA Index, under several constraints. Among these constraints, the fund limits its sector tilts within 5 percentage points of a market-cap-weighted benchmark. This constraint helps the fund avoid loading up on interest-rate-sensitive utilities. Rather than simply targeting individual stocks with low volatility as SPLV does, this fund takes into account how stocks interact with each other in its portfolio-construction process. This results in a portfolio with stocks that generate relatively stable earnings and are less sensitive to the business cycle than the broader market. Consequently, the fund should hold up better during market downturns. However, it also likely will underperform during bull markets. For example, when the market, as represented by the MSCI USA Index, was down 37% in 2008, the MSCI USA Minimum Volatility Index was only down 26%. However, in 2013, the market returned 33% while the fund posted a 25% return.

To view this article, become a Morningstar Basic member.

Register for Free

Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.