Beyond SPLV: The Expanding Universe of Low Volatility ETPs

The spike in volatility that hit a climax on Monday has apparently passed with the swiftness of a summer thunderstorm. Of course, as I explained more than six years ago in What My Dog Can Tell Us About Volatility, things are never really quite the same after the storm passes, which is why we often encounter a phenomenon I call echo volatility.

Most investors – and I know I am the exception here – do not like volatility and actively seek out strategies that minimize the volatility of their portfolios. This low volatility approach has a great deal of merit and a fair amount of academic studies to support the rationale behind low volatility investing. For those who might not be interested in wading through the academic literature, the chart below shows how SPLV has significantly outperformed SPY since its launch, with substantially less volatility along the way.

Since the exchange-traded revolution began, investors have been blessed with a variety of low volatility sector ETPs, such as utilities (XLU) and consumer staples (XLP) as well as a strong selection of value-oriented ETPs (e.g., IWD and VTV) and dividend-focused ETPs (e.g., VIG, DVY and SDY), but it was not until May 2011 that there was an exchange-traded product that specifically target low volatility holdings. Enter the PowerShares S&P 500 Low Volatility Portfolio ETN (SPLV), which immediately began attracting a following and now has $3.4 billion of assets. SPLV had the benefit of being first to market, but its success has prompted the launch of many similar products, of which the most successful has probably been the iShares MSCI USA Minimum Volatility ETF (USMV). Since then, PowerShares and iShares have expanded their product line of low volatility ETPs to cover international stocks (EFAV,ACWV, IDLV) and emerging markets (EEMV, EELV).

The newest battleground in the low volatility race is a U.S. market cap focus, with the launch by PowerShares of the PowerShares S&P Mid Cap Low Volatility Portfolio (XMLV) ETN and the PowerShares S&P Small Cap Low Volatility Portfolio (XSLV) ETN earlier this month. I mention these two new entrants because the distinction between these two and SPLV is much more than the market cap. Indeed, the differences in sector weighting are at least as substantial as the differences in market cap. Starting with SPLV as a benchmark, here the current sector weightings are 31% utilities, 24% consumer staples and 15% financials. In contrast, XMLV is weighted with 51% financials, 24% utilities and no other sector representing more than 8% of the portfolio. Not too dissimilar is XSLV, which is weighted 50% in financials and 16% in utilities. The bottom line is that these two new products are not just smaller cap versions of SPLV, but portfolios with a strong financial component, very little exposure to consumer staples and more exposure to sectors such as information technology and industrials, so the redundancy between SPLV and either XMLV or XSLV is smaller than one might expect.

Aggressive and conservative investors alike should make an effort to have a portion of their portfolio dedicated to lower volatility instruments. While more traditional sector, value and dividend approaches still make some sense, the expanding menu of targeted low volatility products certainly deserve a long look as well – preferably before the next big volatility storm.

[source(s): ETFreplay.com]

Related posts:

• Performance of Volatility-Hedged ETPs
• Investing with a Target Volatility Approach
• Performance of VIX ETP Hedges in Current Selloff
• Dynamic VIX ETPS as Long-Term Hedges
• Comparing SPLV and VQT
• High and Low Volatility ETPs
• Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR
• The Case for VQT
• Cheating with Partial Hedges
• What My Dog Can Tell Us About Volatility

Disclosure(s): none

SPLV vs. XLP

The more I think about it, the less I understand the need for even more low volatility ETPs. Sure, I understand that in high volatility markets many investors want a more conservative portfolio that is insulated against sharp moves in the wrong direction.

In that respect, I can somewhat understand the appeal of the hugely popular PowerShares S&P 500 Low Volatility Portfolio ETN (SPLV), which has now attracted more than $1 billion in assets in the eight months since it launched. Just last week, in Comparing SPLV and VQT, I noted that SPLV’s approach to lower volatility “is heavy on defensive stocks, with the current top sector allocations in utilities, consumer staples and health care stocks.” In fact, following its recent quarterly rebalancing, SPLV currently has approximately 31% of its portfolio invested in utilities, with another 30% in consumer staples. [see SPLV’s top holdings here]

So what is it that SPLV offers over and above an investment in a utilities ETF like XLU or a consumer staples ETF like XLP? Not much, as far as I can tell. I terms of performance, XLU trounced SPLV throughout 2011 and as the chart below shows, finding a distinction between the performance of SPLV and XLP since the former’s launch last May looks a lot like splitting hairs – though to be fair the gap may become more obvious with the recent rebalancing.

One can argue that other approaches which use low volatility stocks (e.g., XLU) are at least as effective in lowering volatility, as are those ETPs that use a dynamic hedging allocation based on an evaluation of market volatility and risk. I touched on two of these in Comparing SPLV and VQT, notably VQT and VSPY.

As I see it, jumping on the low volatility bandwagon is a lot like shunning air travel because of a fear of turbulence. While that is understandable, that cross-country train is going to make it a much longer trip to get to the same destination.

Considering the differences across the investment universe, I realize that not everyone embraces market volatility as a period in which enhanced opportunities arise, so in 2012 one of the themes I will periodically address in this blog will be how to reduce risk, hedge and generate income – though not necessarily all at the same time.

In the meantime, consider for a moment a personal motto, “In volatility, there is opportunity!

Related posts:

• Comparing SPLV and VQT
• Three New Risk Control ETFs from Direxion
• High and Low Volatility ETPs
• Zooming Out on Consumer Spending
• Chart of the Week: Two Bull Legs and Counting…

[source(s): ETFreplay.com]

Disclosure(s): none

Chart of the Week: A Month of New Sector Leadership

During the course of the past month or two, stocks have drifted sideways, lacking buying conviction and strong leadership.

In this week’s chart of the week below, I have tracked the performance of the nine AMEX sector SPDRs over the course of the past month. Note that former leaders financials (XLF) and energy (XLE) are now lagging, while defensive sectors such as utilities (XLU) and health care (XLV) are leading the way. Now I have nothing against utilities and health care, but the next time these two sectors lead a significant bull rally will be the first time in my memory. One or more of technology (XLK), consumer discretionary (XLY), materials (XLB) or perhaps financials needs to take a leadership role to give the next bullish leg the type of strength that portfolio managers can believe in.

A good defense may win championship, but it will not light a fire under potential buyers.

For more on related subjects, readers are encouraged to check out:

• Chart of the Week: Four Key Sectors Struggle
• Three Pivotal Sectors: Financials; Homebuilders; and Consumer Discretionary
• Sector Performance in the Last Two Bull Moves

[source: StockCharts]

Disclosure: none

Chart of the Week: Two Bull Legs and Counting…

In the seven months since stocks bottomed and rallied some 61% (in the SPX) to current levels, there have been two distinct bull legs. The first leg began with the low close on March 9^th (or intraday low on March 6^th) and lasted just a little more than three months until the high close on June 11^th. After a one month downturn, the second bull leg was launched on July 10^th and persisted almost two and one half months until September 23^rd. This time the pullback appears to have been more short-lived and has a provisional end date of October 2^nd.

The three charts below – which collectively form this week's chart of the week – capture the sector performance relative to the SPX (the numbers are not in absolute terms) for the first two bull legs and also throws in the first week of what may turn out to be a third bull leg.

Note that in the first two bull legs, financials (XLF) were easily the top performing sector in both instances. Also, on both occasions it was the materials (XLB) and industrial (XLI) sectors that had clear separation from the rest of the sectors and were almost neck and neck for second and third. These three sectors clearly represent a top tier in terms of performance during the most pronounced 2009 bull moves. A second tier of consumer discretionary (XLY), technology (XLK) and energy stocks (XLE) has generally performed slightly above the baseline SPX. The bottom tier consists of three defensive sectors that typically only outperform the SPX in market downturns. In fact, these three sectors, health care (XLV), consumer staples (XLP) and utilities (XLU), were the top three performers during the June 11^th to July 10^th pullback.

Just for fun, I have added the last week of performance in the bottom chart. It is too early to draw conclusions for one week of upward movement, but so far the leading sector for October is energy. If the markets are to continue to set new highs for 2009, a big question will be whether the same sectors continue to lead or whether new leadership emerges. Personally, I do not expect that the same performance hierarchy that has characterized the last two bull legs to continue during the next month or two of upward moves. In fact, I would expect leadership to shift to the second tier in the form of technology, energy or consumer discretionary stocks. No matter what happens, it will be interesting to see how the broader market performs if financials start to lag the other sectors.

[source: StockCharts]

The VIX and Sectors: A One Day Snapshot

I collect a lot of strange and unusual data in the course of trying to be “Your One Stop VIX-Centric View of the Universe…” and it makes sense to share some of those chunks of data from time to time, even when I don’t think it will change the way anyone looks at the market.

Now that I’ve lowered your expectations, I call your attention to the graphic below, which captures the movements in the various sector SPDRs over the course of Monday to Tuesday, a day in which rumors of persistent difficulties at Lehman Brothers (LEH) helped to drag down the financial sector ETF (XLF) to its lowest level since March. The sectors are ordered with the highest weighted ETF at the top (XLK - technology) and the lowest weighted (XLU - utilities) at the bottom. With any luck, the balance of the graphic is self-explanatory.

From a sector and volatility perspective, I found a few interesting tidbits from the graphic. First of all, the change in the VIX and the change in the SPX implied volatility were almost identical, which is what you would expect. I did find it interesting that the VIX jumped more than twice the percentage change in the mean IV across the nine sector ETFs. Drilling down a little more, only three of the sectors had an increase in IV that was higher than the jump in the VIX -- and in each instance this was just barely the case.

I have highlighted in green the two sectors in which the price of the ETF increased at the same time that implied volatility increased. For the consumer discretionary sector (XLY), the change is not particularly dramatic, but for the materials sector (XLB), there is a substantial jump in IV on the heels of increasing price. Needless to say, this is unusual.

Part of the explanation for the large increase in the VIX (and SPX IV) relative to the individual sectors may come from the fact that the four most heavily weighted sector ETFs all had a substantial rise in IV, but even when taking this into consideration, the change in the VIX exceeds the change in the sum of the weighted parts.

Finally, for anyone who followed my fearogram and SPX-VIX correlation analysis last year, you may recall that the median daily percentage move in the VIX is -4.2x of the daily move in the SPX. For the record, yesterday the VIX moved 3.6x in the opposite direction of the SPX. In percentage terms, this is a fairly typical negative daily correlation number. [Disclosure: Long LEH at time of writing.]