Here’s an investing strategy that smooths out some market ups and downs

Not everyone likes to live dangerously in the markets. Investors have long known that a low-volatility strategy can offer some exposure to the stock market with a little less risk and not much less reward. There are many ways to use funds to accomplish that, but one money manager warns that the devil, as always, is in the details. Richard Daskin, who runs his own firm, RSD Advisors, suggested comparing two such funds: the iShares Edge MSCI Min Vol USA ETF

USMV, 0.06%

 , and the Invesco S&P 500 Low Volatility ETF

SPLV, 0.20%

 . Both have been around since 2011. Both offer broad exposure to U.S. stocks, aim for smoother returns than other options, and charge low fees – 15 basis points for USMV and 25 for SPLV. But the comparisons end there. SPLV accomplishes its goal by selecting individual stocks – about 100 out of the S&P 500

SPX, 0.03%

  – that are likely to be less volatile than others. USMV, in contrast, contains more stocks – about 200 – selected from a broader basket, the MSCI USA Index, which contains 643 companies. Crucially, it takes a more “holistic” view of the stocks in its portfolio, considering how they interact with each other, in the words of Morningstar, which gives the fund four stars and a silver rating.

This managed volatility ETF has moved in near lockstep with the broader market in recent months. Over the longer term, according to Morningstar, it should “offer a smoother ride.” What does that mean? Right now, Daskin noted, SPLV is overweight utilities, financial services and real estate stocks. For example: real estate makes up over 19% of its overall exposure, while only accounting for about 2.5% of the S&P 500 index. And the fund is greatly underweighting other sectors, like technology, to make up for that. Real Estate Utilities Technology USMV 8.99% 8.04% 10.19% SPLV 19.43% 24.40% 0.99% S&P 500 2.47% 2.77% 21.84% Source: Morningstar That’s not necessarily bad. Real estate and utilities are well-known for underperforming when interest rates are on the rise – and when investors think they may start to rise. But it’s almost universally agreed that the Federal Reserve will announce an interest rate cut when it meets today, and many investors expect more rate cuts ahead. Daskin thinks the sector concentration offers a different lesson: “Know what index you’re buying.” Don’t assume all low-volatility approaches are the same, he added. According to a recent Morningstar analysis, USMV’s holdings “tend to enjoy more-stable cash flows and less-volatile returns than the typical constituent in the MSCI USA Index. But more volatile names can make the cut if they have low correlations with the other stocks in the portfolio.” When different asset classes are more highly correlated, it means they are more likely to behave the same. That can be dangerous in times of market volatility. In a recent note from research firm Datatrek, co-founder Jessica Rabe commented, “There’s been virtually no volatility for well over a month in US equities, at least the way we measure it: how many days the S&P 500 rises or falls by 1% in a given trading session.” If historic trading patterns hold, markets are likely to be choppier in the early fall months – although central bank easing tends to keep markets quiescent, Rabe noted. Still, Daskin likes low volatility strategies not for short-term ups and downs, but as part of a balanced overall portfolio. Research into historical returns shows that returns for these strategies “can be superior over a standard market cycle,” he explained. Some theories suggest that’s because many investors opt for more volatile stocks to attempt to grab some upside. If fund managers pile in to those stocks, prices go up. Daskin pairs low-volatility ETFs like the ones mentioned here with specific stock selection in areas that may take on more risk, such as biotechnology or small-cap stocks. Related: Here’s an ETF that proves there is intelligent life in the universe after all



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