Christine Benz: Hi, I'm Christine Benz for Morningstar.com. How can retirees maintain equity exposure while also keeping a lid on volatility? Joining me to share three ETF picks for the job is Ben Johnson. He is Morningstar's director of global passive strategies research.
Ben, thank you so much for being here.
Ben Johnson: Thanks for having me, Christine.
Benz: Ben, let's talk very generally, and of course, all retirees are different, but let's just talk about why many/most retirees should maintain ample equity exposure even once they begin drawing down from their portfolios.
Johnson: Well, to take it from the general, and I'll make it hypothetical and specific. So, let's assume the case of Ben Johnson, and I'm thinking about my retirement, which is still many years away. My life expectancy is longer than my parents' life expectancy, is longer than my grandparents' life expectancy. So, if I'm going to live longer, I've got a longer time horizon, which lends itself to increasing my ability to take risk over that longer time horizon. So, in that context, it makes sense to take more equity risk over a longer period of time.
Benz: Let's talk about some specific funds that investors might use where they know they want to maintain X equity exposure in their portfolio into retirement, but they would like to try to reduce the risk of--or the volatility of--their equity portfolio a little bit. You brought some ETFs that you think address this challenge. One is an iShares fund that is specifically focused on the lower-volatility subset of the U.S. equity market. So, let's talk about that. What is the case for low-volatility products like this one, and what do you like about this specific fund?
Johnson: So, the case for low volatility isn't so much a return-driven case. It's a volatility-driven case. So, these portfolios aim to reduce the volatility of your equity exposure versus just owning the market outright. So, the first fund that you mentioned is the iShares Edge MSCI USA Minimum Volatility ETF. The ticker for that is USMV. So, this ETF looks to create the least volatile portfolio--not possible--but a less volatile portfolio, within sort of the universe that is the MSCI USA Index, which is an all-cap U.S. equity benchmark.
So, it doesn't necessarily take the least volatile stocks out of that universe. It looks to combine stocks that have different characteristics that in aggregate have a much less volatile profile than owning the benchmark outright. So, every once in a while, people look at the portfolio and say, wait a minute, Newmont Mining is in USMV, what does this mean? Newmont Mining is a gold-mining firm; it's up, it's down, it's left, it's right, it's sideways. It's in there because it has very specific characteristics, because it has low and often negative correlation with other stocks within that portfolio. It almost acts somewhat counterintuitively as a ballast of sorts in the context of the overall portfolio. So, it's a unique process, and the ultimate outcome is that over its history the volatility profile of USMV has been pretty consistently below and significantly below just owning the total stock market or owning U.S. equity exposure through, say, the S&P 500.
Benz: Another fund you like of this ilk is the ticker SPLV. Let's talk about that one.
Johnson: So, actually, an Invesco fund, so Invesco S&P 500 Low Volatility ETF SPLV. This is a different approach to creating a low-volatility profile. So, it starts with the S&P 500, and it looks for the least volatile 100 stocks from those 500 within its starting universe, and then it weights those stocks by the inverse of their volatility. So, it creates a portfolio of the least volatile stocks within the S&P 500 and gives the greatest weightings to the least volatile of the least volatile. So, this is an interesting approach. It's somewhat more straightforward. It's somewhat more intuitive. The difference here is that it doesn't have the same constraints in place as does USMV, which most notably can lead itself to having very significant sector level concentrations.
So, if you were to look at this fund's portfolio today, those are evident in a significant overweighting in the utilities sector and a significant overweighting in the real estate sector, both of which are very much interest-rate-sensitive and potentially introduce other new, maybe unwanted or unforeseen risks into the portfolio. So, something to keep in mind.
Benz: Perhaps a more tried and true way to think about having an equity portfolio without as much volatility as the broad market would be to just focus on high-quality dividend-paying companies. So, let's talk about a fund that you and the team like in that particular area.
Johnson: So, Schwab US Dividend Equity ETF SCHD, is one of our longtime favorites. It looks for good firms and good firms that have done a good job of returning cash to shareholders, chiefly through dividends, but there's also a lot of share repurchasing that's been going on amongst these organizations. So, it looks for a long track record of sustained and ideally growing dividends over time. It screens out everything that doesn't fit that profile, and it's got a bit of a yield bent to it as well. So, it introduces a bit of a value screen of sorts. The net result is a portfolio of very high-quality companies, companies that inherently have sort of defensible business models. They've got wide economic moats around them. Their cash flows are more stable, they are more predictable, and thus, they are able to continue to pay out dividends to their shareholders and grow those dividends over time. Long been a favorite of ours within the dividend bucket of ETFs.
Benz: A good short list of ETFs that retirees can investigate and see if they are possibly interested in tweaking their equity exposure. Thank you so much for being here.
Johnson: Thanks for having me.
Benz: Thank you for watching. I'm Christine Benz for Morningstar.com.