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3 Impressive Low-Volatility Funds

Alex Bryan, CFA
Susan Dziubinski

Susan Dziubinski: We've seen an increase in market volatility this year. As a result, some investors may be thinking about how to maintain exposure to equities yet perhaps take a little risk off the table at the same time. For some, low-volatility ETFs and funds could fit the bill. Joining me today to share three of his favorite low-volatility funds is Alex Bryan. Alex is director of passive strategies research for Morningstar North America.

Alex, thank you for joining me today.

Alex Bryan: Thank you for having me.

Dziubinski: Now, your first pick is a pretty straightforward choice in the space.

Bryan: That's right. This is Invesco S&P 500 Low Volatility ETF. This fund basically just starts out with the stocks in the S&P 500. It ranks them on their volatility over the last year, and then it targets the 100 that have exhibited the lowest volatility and weights them by inverse of their volatility, so that the least volatile stocks get the biggest weightings in the portfolio.

It does this without any limits on how big the sector weightings can be or how much turnover there can be in the portfolio. That can lead to some pretty concentrated bets on things like utilities and healthcare stocks, for example. Overall, this offers very potent exposure to stocks with low volatility, which have historically offered better downside protection than the market and have tended to offer better risk adjusted performance than the market over long periods of time.

Dziubinski: Your second idea here is also an ETF focusing on U.S. stocks, but it takes a slightly different approach.

Bryan: That's right. This is the iShares Edge Minimum Volatility USA ETF, ticker is USMV. This fund uses a more holistic approach to reduce volatility. It's not only looking for stocks with low historic volatility, but it's also looking for stocks that have historically exhibited low correlations with one another. It's attempting to create the portfolio that's expected to have the lowest possible volatility using a complicated optimization framework under a set of constraints designed to preserve diversification.

Now, this holistic approach that's focusing on the entire portfolio leads to a better diversified portfolio. It limits how big its sector weightings can be, it limits how much turnover can happen in the portfolio, but effectively the end result is similar to the Invesco fund we just discussed. It offers better downside protection and it also offers a volatility reduction relative to the broader market. I think this is a good option for investors that are looking for a core allocation to a low-volatility fund. I think the fact that it constraints its sector weighting makes it a better core holding than the Invesco fund that we talked about.

Dziubinski: Got you. Your last pick you want to talk about toady is actually mutual fund, and it takes a global approach.

Bryan: That's right. This is the Vanguard Global Minimum Volatility Fund. This fund invests in both U.S. and non-U.S. stocks. It's using a similar approach to the iShares fund where it looks at both individual stock volatility, as well as how stocks interact with each other in the portfolio. It tries to construct the least volatile portfolio possible. 

There is a couple of differences here between this fund and the iShares fund. Number one, in addition to the fact that it goes global, it also hedges its currency risk as a way of further mitigating volatility. Secondly, this is an actively managed strategy, in that it doesn't track an index. That gives the managers a bit of flexibility about when they want to rebalance the portfolio, but this is still a rules-based strategy that uses a very similar type of framework to the iShares fund. It charges a competitive 25 basis points expense ratio and has also been pretty effective at reducing volatility and offering better downside protection in the boarder markets. If you are looking for one-stop shop for broad equity exposure, both to U.S. and non-U.S. stocks, I think this is a really good option for more risk-averse investors.

Dziubinski: That's great. It's a very interesting group of funds. Thank you so much for joining me today, Alex.

Bryan: Thank you for having me.

Dziubinski: For Morningstar.com, I'm Susan Dziubinski. Thanks for watching.