These 2 ETFs Boast Shelter From Volatility, but at What Cost?

We've talked about risk-managed products that focus solely on derivatives, so let's take a look at a relatively derivative-free risk avoidance strategy in the low volatility portfolio. The two exchange-traded funds we'll review and compare to the SPDR S&P 500 ETF Trust are: Fidelity Low Volatility Factor ETF and Deltashares S&P 500 Managed Risk ETF . DMRL is the newest fund of the group, so the analysis will cover from its launch in August 2017 to this March 4. First, let's take a look at each fund and how it goes about implementing its low volatility strategy. The DL on FDLO The Fidelity Low Volatility Factor ETF was launched in September 2016 and tracks the Fidelity U.S. Low Volatility Factor Index. The fund sports a 29-basis point expense ratio, meaning that shareholders with $1,000 invested over a calendar year would expect to pay $2.90 in fees over that holding period. The index methodology spells out a fairly straightforward security selection by starting with a universe of the top 1,000 U.S. equities by market capitalization and then calculating trailing 5-year standard deviations of company price returns, and reported earnings per share and finally, the trailing 5-year sensitivity to overall market returns (known as a stock's Beta). Each metric is given a 33% weight and an overall score is calculated. Depending on the number of companies in a given sector the top decile, quartile or tercile ranked names are chosen for the final constituent list. In terms of the fund's ability to manage overall volatility, since Aug. 2, 2017, I calculated annualized volatility of 22.24% as compared to 24.08% for SPY, so there's not a lot of volatility control here. This is reflected in the returns of this fund, as it has returned 15.30% on an annualized basis since that date as compared to the 16.68% annualized return by SPY from Aug. 2, 2017 to March 4 of this year. DMRL's Numbers Game The 35-basis point Deltashares S&P 500 Managed Risk ETF tracks the S&P 500 variant of the S&P Managed Risk 2.0 Index Series. The index methodology was developed by fund sub-adviser Milliman Financial Risk Management and is quite complex. For example, a basic index calculation formula takes the sum of the number of shares multiplied by their prices and divides that all by a divisor, something like this: This is what the calculation formula for this index looks like: The overall approach ties in no less than 11 parameters and 29 variables as it looks to calculate a synthetic put option overlay and develop and use volatility targets that tie into both asset selection and position weighting. Essentially the methodology involves using a lot of higher math to continually optimize position weights and synthetic hedging activity. The portfolio seems to have all 505 holdings of SPY as well as a position in some Emini S&P 500 futures. In terms of the fund's ability to manage overall volatility, all that math checks out. Since inception I calculated annualized volatility of 16.74% as compared to 24.08% for SPY. One thing many investors forget is that volatility measures movements down and up, so when you talk about keeping volatility low, you're talking about looking to minimize both big down and up days. This is reflected in the returns of this fund as it has returned 12.65% on an annualized basis since inception as compared to the 16.68% annualized return by SPY over the same period. For what it's worth, this type of approach is what you might see in an institutional account or a fixed index annuity product. Another good example of the type of democratization that ETFs bring to the retail market. My Take Where this gets interesting is when you take a look at each of these funds' risk-adjusted returns, or Sharpe Ratio as well as each fund's correlation to SPY. For the period of the full calendar years between Dec. 31, 2017 and Dec. 31, 2021 here are the results: Fund Ticker Sharpe Ratio Correlation SPY 0.67 - FDLO 0.66 .967 DLRM 0.60 .732 You may look at these figures, pair them with the returns presented above and decide that FDLO is the clear Low Volatility winner I would offer that I don't see a lot (if any, really) volatility controls in this portfolio given how close it sits on top of SPY in the chart below as well as the very high correlation to SPY. If what you are looking for is sharp downside protection, then I would point you toward the folks at Innovator or First Trust for their option-based defined outcome funds. If what you are looking for is less volatility in your overall portfolio long-term and are willing to give up not just some extreme lows but also some of the highs, then I would say take a closer look at DLRM.

These 2 ETFs Boast Shelter From Volatility, but at What Cost?

Here we compare the Fidelity Low Volatility Factor ETF and Deltashares S&P 500 Managed Risk ETF to the SPY fund -- and remind that volatility goes two ways, down and up.

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