Scanning the Minimum-Volatility ETFs

 | Jun 18, 2014 | 1:08 PM EDT
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For the first time since I can remember running breakout scans, a minimum-volatility exchange-traded fund hit the screens. Simply put, the minimum volatility ETFs seek to track the investment results of an index, in the aggregate, using components that have lower volatility characteristics relative to the broader index. There isn't a specific hedge against volatility, nor does the ETF change components if volatility spikes. It is actually pretty simple in its design and pretty useless if you ask me, but we'll get to that in a minute. 

The appearance of the iShares MSCI EAFE Minimum Volatility (EFAV) on a scan made me feel like I had been missing out on a good opportunity. So I thought I'd take a quick look at EFAV against the iShares MSCI EAFE (EFA). At first glance, this pair certainly favors the EFAV year to date. The minimum volatility ETF outperforms EFA when the VIX spikes. Just a note, for comparison purposes, I use only the Volatility Index (VIX) for all the pairs. Surprisingly though, EFAV continued to outperform, even as the VIX fell. After six months, EFAV almost doubled the return of EFA. Eureka, we have something here.




So I expanded out to the emerging markets, comparing the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) with the iShares MSCI Emerging Markets ETF (EEM). On a year-to-date basis, this one wasn't as impressive; however, not all was bad. The minimum volatility ETF did do a tad better when the VIX spiked and a little worse when volatility faded. That's actually as advertised, so it's not a bad thing at all. Overall, this one is somewhat appealing.




Lastly, I compared the iShares MSCI USA Minimum Volatility (USMV) against the SPDR S&P 500 (SPY). Once again, year to date, this one performed somewhat as advertised. The USMV did slightly better on VIX spikes and slightly worse in declining volatility. Still, the difference has been so slight, the correlation still runs high.




But, what about longer term? Can we just rely on six months? I don't think so, so I took this back 2.5 years, as that is as far back as we go. I am just looking at the SPY vs. USMV here to get an idea on whether these ETFs are worth longer-term consideration.


USMV, 2.5 Years


If we look back to 2012, it is still clear that the USMV does slightly better, or least no worse, in times of a VIX spike. However, the difference between the performance of USMV at 47% since the beginning of 2012 and the SPY's gain of 64.25% is too big to ignore. The cost of lower volatility for 2.5 years came in at 17%.

For comparison's sake, I can buy the SPY at $195 right now and then buy a December 2016 $195 put for around $22.50, or 11.5%. That means my loss, over the next 2.5 years is 11.5%, less any dividends I receive. Those dividends are going to cut that 11.5% down to around 7%.

Obviously, there are other approaches or legs that could be added to the trade to adjust risk/reward, but to keep things simple, I would much rather limit my downside to around 7% and capture all the potential upside less than loss on the puts, rather than buy the USMV and open myself to much more downside than 7% all while sacrificing potentially more than 7% on any big upside move.

The EFA-EFAV had similar results over the same 2.5-year period. Maybe not a huge surprise, but the EEMV almost looks like a worthy replacement to the EEM, as the 2.5-year gap was half what I saw in the EFA-EFAV and only one-third of the USMV-SPY pair. In the end, I would only consider using EEMV and use a put protection strategy if buying SPY or EFA.

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