Tag: financials

Last weekend, there was a fascinating article about minimum volatility ETFs. It was written by one of my favorite Wall Street Journal columnists, Jason Zweig. In this article, he shared a lot of wisdom, which I will highlight more here.

What is a minimum volatility ETF?

One of the most common ways to measure risk in an ETF is to track its volatility. So, investing in a minimum volatility ETF may make sense for investors seeking to reduce risk. One of the largest low volatility ETFs is the iShares MSCI USA Min Vol Factor ETF (ticker: USMV), with over $30B in assets. The chart below shows it performance since its inception in October 2011, which generally lagged the S&P 500 (ticker: IVV). However, its volatility was noticably lower.

Why did this ETF produce lower risk and lower return?

This ETF is able to lower risk through the use of optimization, much like the ETFMathGuy portfolios. However, we don’t limit our optimal portfolios to equities like minimum volatility ETFs. We consider bonds, commodities and other alternative investments too. ETFMathGuy also uses backtesting that includes transaction costs to build portfolios to maximize returns.

The fund’s index uses an optimization algorithm to build a “minimum variance” portfolio—one that considers correlation between stocks—rather than simply holding a basket of low-vol stocks…

USMV Factset Analytics Insight (https://www.etf.com/USMV)

So, this ETF consists of stocks which typically emphasize lower volatility sectors like financial, utilities and real estate. These sectors are often termed “value”, rather than “growth” investments, in part due their issuance of dividends. Consequently, optimization to produce a minimum volatility ETF removes some market risk, generating a beta of 0.87. But, as we can see in the economic cycle from 2011 – 2020, the return also lagged the market.

Recent performance of minimum volatility

This year’s pandemic has certainly affected the stock market in significant ways. Investments favored by minimum volatility ETFs (financials, utilities, and real estate) have been significantly impacted by coronavirus lockdowns. However, technology has done very well, as remote work has increased the demand for technology systems and services. Unfortunately, technology is typically more of a “growth” investment. So, minimum volatility ETFs often limit their exposure to growth stocks to reduce volatility. In the ETFMathGuy portfolios, technology has been a noticeable portion this year, and has led to encouraging year-to-date returns and performance statistics.