Last week’s big swings in the stock market were a shining opportunity for funds marketed as a way to reduce portfolio volatility, but there are some considerations investors should be aware of before jumping in. First, the leading funds marketed as “low volatility” or “minimum volatility” have lived up to their name. Many have held up better in recent weeks than the SPDR S&P 500 ETF Trust (SPY), which fell 3.2% from August through Monday’s close and 2% in the third quarter. Low volatility funds also fell less than the index during the Aug. 5 selloff. The largest fund is BlackRock’s iShares MSCI USA Min Vol Factor ETF (USMV), with about $24 billion in assets. Robert Hamm, head of U.S. factors and co-head of Outcome ETFs at BlackRock, said the fund is designed to differentiate itself from the rest of an investor’s portfolio, not just be a way to gain exposure to a defensive sector. “We’re not just looking for stocks with low volatility, we’re also looking for stocks with low correlation to other stocks. Sometimes we hold high-risk stocks to diversify the rest of the portfolio,” Ham said. To that end, the fund limits the weighting of each individual stock to 1.5% during its semi-annual rebalancing, and it also has guardrails to ensure that sectors don’t diverge too much from the overall market. USMV’s management fee is 0.15%. Some other funds tend to be more defensive, with higher exposure to areas such as utilities. Admittedly, these types of funds tend to underperform when the market rises. Ham said USMV’s goal is to deliver risk-adjusted returns that are at or above the market over the long term. Structured Products Another group of ETFs that investors may turn to in volatile times are income funds. Those that use options such as call writing to generate yield have been particularly popular in recent years. JPMorgan Asset Management is a leader in the field, with its Equity Premium Income ETF (JEPI) and Nasdaq Equity Premium Income ETF (JEPQ) currently holding more than $48 billion in combined assets, according to FactSet. These funds have outperformed the S&P 500 and Nasdaq 100 indexes, respectively, over the past month. “We aim to provide investors with high, stable income and good total returns with reduced volatility and beta relative to the market. During the recent market rotation and increased volatility, the ETF has performed well, demonstrating its character as a more defensive equity strategy,” a JPMorgan Asset Management spokesperson said in a statement. JEPI 1D Mountain JEPI has outperformed the S&P 500 over the past month. However, the call selling could undermine the fund’s long-term performance against the overall market, especially if a sharp rebound occurs. “The problem is, if you sell after a volatile market downturn, you theoretically get a higher premium on a percentage basis, but you also lock in the upside selling at a lower level,” said Arch Index CEO Yan Tan. That means a fund’s yield may not be the best indicator of which fund makes the most sense for investors. Many funds generate yield by selling call options, and call options that are closer to the money — that is, call options with lower upside potential for the fund — will yield higher yields. “In our view, you need to have a responsible yield target. You need to provide a balanced return with upside growth potential, because at the end of the day, these are still equity portfolios,” said John Brelo, senior portfolio manager for Invesco’s Income Advantage strategy, which launched two such funds in July. Another popular type of structured product ETF is the so-called buffer fund, which uses options to provide explicit downside protection. But investors should be aware that these funds are designed to be held for the full period, often 12 months, and buying late or selling early can lead to returns that don’t match what’s on the label. Less Visible Asset Classes Stocks and bonds make up the bulk of most investors’ portfolios, but there are other options for investors looking to diversify and reduce volatility. Gold is one area that has performed well recently. The SPDR S&P Gold Shares Fund (GLD) rose 6.2% in the third quarter and 2.4% in the past month. GLD 3M Mountain Gold has outperformed the S&P 500 since early July. Another area is preferred stock funds. The largest preferred stock ETF, iShares Preferred & Income Securities ETF (PFF), rose 0.5% in the third quarter but is down 1.4% in the past month. Gary Kessler, a portfolio manager at Goldman Sachs Asset Management, said the preferred securities market has changed significantly in recent years, with more custom products being sold over the counter, and investors should check what exactly the funds hold. For example, Goldman’s Access US Preferred Stock and Hybrid Securities ETF (GPRF), which launched less than a month ago, holds securities that trade on and off exchanges. Preferreds are like a hybrid between stocks and bonds, and they help tame volatility, especially when market movements don’t erode the creditworthiness of the issuers, which are often banks. “Since Dodd-Frank, the banks have been more regulated, which has tame volatility,” Kessler said, referring to reforms enacted after the 2008 global financial crisis. “In the preferred securities market, you have more call capabilities, which helps in terms of interest rate volatility and its impact.” The group could also benefit when the Federal Reserve tapers interest rate policy. Kessler said preferreds generally do well when the Fed is easing monetary policy, but the market doesn’t have as long a duration profile as it used to because many over-the-counter securities can be “called” by issuers.
CHOOSE LANGUAGE
SELECT LANGUAGE BELOW
