Get Thee to a Low-Volatility Fund

 | Apr 10, 2012 | 11:00 AM EDT  | Comments
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Stock quotes in this article:

HILO

,

SPLV

,

SLVY

So much for the notion that revived hopes for an additional round of quantitative easing from the Fed, which could have help stocks stave off a loss to open the week. Equities tumbled Monday in reaction to weak jobs data from vacation-day Friday, pushing the losing streak for major indices to four trading days.

Suddenly, now, we're heading into a tremendously important earnings season, and all eyes will turn to these reports for some much-needed good news. If it isn't there, we could have some challenging days ahead, as the slowing job growth has rattled investor confidence quite a bit. I'm anticipating more weakness in upcoming sessions. If earnings reports from bellwether companies don't knock investors' socks off, anxiety could spread rapidly. Expect markets to whipsaw in coming days, oscillating between gains and losses as investors try to read the tea leaves from disappointing jobs figures and the lead-off hitters for corporate earnings season.

In any case, this type of environment is a perfect setting to shift a bit of exposure towards some of the ETFs that target low-volatility stocks. This highly innovative idea is pretty straightforward: These products hold portfolios of stocks that have exhibited the lowest historical volatility, with the goal of reducing downside risk when markets encounter turbulence. Past performance is, of course, not indicative of future returns. But these products have proven to be pretty effective at accomplishing their stated objectives over the last week as equity markets have tumbled under a wave of bad news.

Through Monday, most low-volatility ETFs were down quite a bit over the previous four sessions, as few equity funds have been spared from the wave of bad news. But these products have generally held on to their value much more efficiently than have "plain vanilla" ETF peers. The EGShares Emerging Markets High Dividend Low Volatility ETF (HILO) lost about 2.5% over the past week, beating the ultra-popular VWO Vanguard MSCI Emerging Markets ETF (VWO) by about 70 basis points.

Meanwhile, the PowerShares S&P 500 Low Volatility ETF (SPLV) has lost only about 1.6% over the previous four sessions, putting it about 100 basis points ahead of SPDR S&P 500 (SPY). The small-cap focused Russell 2000 Low Volatility ETF (SLVY) has similarly held its ground. That fund is down about 3.6% over the past four trading sessions, but remains far ahead of iShares Russell 2000 Index (IWM), which has lost about 4.3% over the same period.

In other words, the investment thesis behind these ETFs is valid: Low-volatility ETFs are proving their worth as tools for scaling back risk profile and curtailing losses when stocks head south.

There's a tendency among investors to focus only on the best tools to maximize gains, but it's equally important to pay attention to minimizing losses when stocks slide. Preserving capital in challenging environments puts you in much better position to capitalize when the bulls return, and low-volatility ETFs are cheap, easy ways to take a bit of risk off the table when stocks start to stumble.

If you're able to time market swings even  in a general way, these products can provide a safe haven for riding out the storm while still keeping plenty of skin in the game and being able to participate in any sudden rallies. If you're concerned about the immediate prospects for global equity markets, but are not quite ready to jump straight to bonds, low-volatility ETFs provide a nice in-between point on the risk spectrum. Dialing back the risk just a bit can save you a few basis points if stocks continue to struggle without requiring you to incur significant opportunity costs if they pick up gains.

As for myself, I'm not yet hitting the panic button -- I believe there is plenty of room to run higher throughout the remainder of 2012. But for now, these ETFs -- HILO, SPLV and SLVY -- are looking like a good way to ride out the rocky stretch ahead.

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