Plenty of interesting things are happening in the world of exchange traded funds (ETFs) this year. The first being that through the first seven months of 2021, U.S.-listed ETFs hauled in $518 billion in new assets.
For those keeping score at home, that represents an annual record – one set in just seven months – and it puts ETFs on pace to gather nearly $800 billion this year, as long as equity markets don't dramatically turn sour, forcing outflows.
Another interesting and related point is that funds dedicated to four of the five primary investment factors – growth, quality, size and value – are flowing positive this year. Conspicuous by its absence from that list is low volatility.
Yes, there have been intermittent bouts of elevated equity market turbulence this year, but apparently those instances haven't been lengthy enough to compel market participants to embrace low vol ETFs. Should such a scenario occur or for investors looking to be prepared, the VictoryShares US Multi-Factor Minimum Volatility ETF (VSMV) may prove preferable to competing volatility reducing funds.
Vanquishing volatility with VSMV
VSMV follows the Nasdaq Victory US Multi-Factor Minimum Volatility Index, and the fund is far from the standard low volatility product.
The ETF “employs a two-step approach that aims to deliver superior risk-adjusted equity returns, while seeking to minimize the overall portfolio volatility,” according to issuer VictoryCapital.
That two-pronged process evaluates stocks based on fundamental traits, including earnings quality, momentum, profitability and valuation. Conversely, a traditional low vol fund simply gauges volatility. As such, those products are often heavily allocated to richly valued defensive sectors. Over long holding periods, those groups usually do an admirable job of limiting drawdowns, but they also limit an investor's upside, underscoring the rub with old guard reduced volatility strategies – a rub VSMV mostly avoids.
“Over the long run, low-volatility strategies have proved effective at cutting back on statistical measures of risk,” writes Morningstar analyst Daniel Sotiroff. “But they differ from many other strategies in that they aren’t designed to beat the market. Instead, the expectation is marketlike total returns with less risk, which sets them up for better risk-adjusted performance. Cutting back on risk may make them an easier stock strategy to stick with, but they come with trade-offs and are by no means a substitute for cash or bonds.”
In plain English, an investor buying a standard low volatility is buying a product that's designed to limit downside and not capture all the upside in a strong bull market. Indeed, that trade-off is at play with VSMV. The fund is lagging the S&P 500 over the past year, but during that span, VSMV is topping the S&P 500 Low Volatility Index and the MSCI USA Minimum Volatility (USD) Index by notable margins.
Some VSMV vindication
“Low-volatility strategies underreact to market movements, be they large upward moves or deep drawdowns," adds Sotiroff. "They typically provide some downside protection when the market goes through a downturn,”
Yes, those sentiments are pertinent regarding VSMV. What's also pertinent is that the ETF allocates over 24% of its weight to technology stocks. That's well above what many competing strategies offer and it's unusual to find a low vol ETF where the top holdings are Apple (AAPL) and Microsoft (MSFT) as is the case with VSMV.
Conversely, take out the 15.37% weight to healthcare stocks, and VSMV has barely any defensive exposure. Bottom line: While VSMV may not keep pace with broader benchmarks all the time, it does trim volatility while offering potential out-performance of relevant competing strategies.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Todd Shriber
Todd Shriber got his start in financial markets as a reporter with Bloomberg News. Later, he became a trader at a Southern California-based long/short hedge fund where he specialized in trading sector and international ETFs leading up to and during the financial crisis. He would later become the web editor at ETF Trends. Currently, he analyzes, researches and writes on ETFs for a variety of Web-based publications and financial services firms.Shriber has been quoted in the Barron's, CNBC.com and the Wall Street Journal. His work has been published on Web sites such as Benzinga, ETF Daily News, ETF Trends, MarketWatch, Fox Business and Nasdaq.com.
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