With the recent government shut-down and debt ceiling limit quickly approaching, the market has once again begun it’s up and down movements. Adding in slowing growth in key emerging markets like China and debt problems in Europe once again beginning to resurface and it’s no wonder why volatility has returned with a vengeance. Funds that attempt to track this “fear” - such as the iPath S&P 500 VIX ST Futures ETN (NYSE:VXX) –have spiked in recent weeks, while the broad market indexes have gone down.
Given the recent volatility of the market, investors could be getting a little seasick. Luckily, there are a variety of new ways for the average retail investor to "smooth out" their ride over the short term.
Minimizing The Roller Coaster Ride
The term volatility gets used a lot by financial journalists and bloggers, but many investors don't really understand the basic concepts behind it. Essentially, volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. In other words, the price of the security can change dramatically over a short time period in either direction. It's the difference between riding a roller coaster and driving across the plains of Kansas. While there is nothing inherently wrong with high volatility stocks, these movements can create panic selling and many restless nights.
And it seems that investors have been having more restless nights as of late.
Over the past two weeks -as the shutdown has commenced and other pieces of global economic data have struggled. The CBOE S&P 500 Volatility Index has surged almost 25%. Meanwhile, the broad market Vanguard S&P 500 ETF (NYSE:VOO) has dropped around 1.76% in only five days. That’s certainly creating some very restless nights for those approaching retirement. Enter low volatility funds.
These funds essentially use screens to kick out high volatility stocks and capture the upside of the market while limiting the downside as well as the “bounciness” associated with markets movements. They also can produce better returns as well. According to index provider MSCI (NASDAQ:MSCI), replacing its standard indexes in a balanced portfolio of U.S., Developed market international and emerging markets with its low volatility versions will produce an extra 1.8% in returns. Meanwhile volatility was cut nearly in half.
A Low Volatility Portfolio
Historically, funds like the Utilities Select Sector SPDR (NYSE:XLU) have been low beta options for investors. However, Wall Street has begun rolling out new products that target this sector of market place. Here are a few portfolio ideas.
With nearly $4.28 billion in assets, the PowerShares S&P 500 Low Volatility (NASDAQ:SPLV) is the king in the space. The fund tracks 100 stocks in the benchmark S&P 500 that have exhibited the lowest volatility over the last 12 months. Top holdings include Kellogg’s (NYSE:K) and utility Dominion Resources (NYSE:D). That focus on limiting the markets bumps has worked well. Since the fund’s inception in 2011, SPLV has managed to outperform the S&P 500 by 1.25%. Not to be out done, the iShares MSCI USA Minimum Volatility (NASDAQ:USMV) similar index and is heavily weighted in consumer staples, healthcare and information technology companies. The SPDR Russell 2000 Low Volatility ETF (NASDAQ:SMLV) can be used to cut volatility in the small-cap portion of a portfolio.
Some of the largest bouts of volatility have come from the international space. Already, higher “risk” stocks, these two market segments tend to move around much more than their U.S. counterparts. The iShares MSCI EAFE Minimum Volatility (NASDAQ:EFAV) can be used as a broad developed market proxy, while emerging market investors have an interesting choice in the EGShares Low Volatility Emerging Markets Dividend ETF (NASDAQ:HILO). The fund is composed of 30 low volatility stocks from various emerging markets and is designed to provide a high yield, but with a lower volatility than the MSCI Emerging Markets Index. The ETF currently yields a juicy 4.87%.
The Bottom Line
The recent government shutdown, potential debt ceiling breach as well as dour global economic news has once again caused volatility to rear its ugly head. Those market swings can cause for some rough nights of sleep for investors. However, a new crop of low volatility funds could be the best ways to smooth out the market’s bumpy ride.
Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.