John Nyaradi September 25, 2014 Comments Off

Although investors usually associate volatility with a bearish stock market, it actually concerns the tendency for a stock – or even an index – to make wild swings in either direction. Since investors fear swings to the downside, bearish volatility is all that matters. Perhaps this is why the Chicago Board Options Exchange Volatility Index (VIX) is often referred to as the “fear index”. As investors become more risk-averse, the stock market is described as more volatile.

There are actually a number of “low volatility” ETFs designed to be more resistant to the broad market downdrafts which occur during so-called “risk-off” days. Nevertheless, it is important to keep in mind what volatility actually means before you invest in a low-volatility ETF.

The ETFs are comprised of stocks which are the least likely to make wild swings. As a result, on a day when the S&P 500 jumps 0.85 percent, a low-volatility ETF is not likely to perform as well, because it might not have the right component stocks which pulled the S&P higher because of their volatility. Volatility is indicated by beta – also known as – the beta coefficient. A stock with a beta coefficient of one moves up or down at the same rate as the market. A stock with a beta lower than 1 moves less-significantly than the market, because it is less volatile. Stocks with higher beta coefficients are more volatile and will make more exaggerated moves – in either direction – compared with the degree of the market’s move.

Low-volatility ETFs are deliberately comprised of stocks with low volatility, so that the investors with low-vol ETF shares are not as likely to get ulcers when the stock market swoons. On the other hand, when the biggest rally of the year takes place, low-vol ETF investors force themselves to feel comfortable with moderate gains.

Stock market volatility historically increases during the period from Thanksgiving until the end of the year. We have recently seen volatility increase because the 38th trading week of the year is historically the most bearish week for the S&P 500. During the month of August, the VIX sank from 16.5 to 11.5. As September progressed, volatility increased until Jon Hilsenrath tipped us off that the magic words “for a considerable time” would be part of the Federal Reserve’s assurance – in the September FOMC Statement – that the federal funds rate would remain low for a considerable time after the bond-buying phase of the quantitative easing program ended. Volatility sank and the VIX was back down to 11.5 within four days.

As we are about to become assaulted by holiday season shopping advertisements, investors should be mindful that we are approaching an historically volatile trading season. Now might be the right time to start shopping for a low-volatility ETF.

One of the most popular low-volatility ETFs is the PowerShares S&P 500 Low Volatility Portfolio (SPLV). which is comprised of 100 of the least-volatile stocks in the S&P 500. The stocks with the most “weight” (stocks which represent the largest percentage of the total ETF holdings) are those with the lowest beta coefficients.

Another popular low-volatility ETFs is the iShares MSCI USA Minimum Volatility ETF (USMV). This ETF also “weights” its holdings according to their individual beta coefficients. USMV focuses on the financial, consumer staples and healthcare sectors.

Investors looking for low-volatility exposure to emerging markets might want to consider the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV). On the other hand, those investors looking for a low-volatility ETF based on developed markets might want to consider the iShares MSCI EAFE Minimum Volatility ETF (EFAV) .

Another low-volatility international ETF is the iShares MSCI All-Country World Minimum Volatility ETF (ACWV) which uses a “passive” or indexing approach (rather than using selections made by a fund manager) based on the MSCI All-Country World Minimum Volatility Index.

Volatility is fun when it’s working in your direction, and not so much fun when it is working against you. Low volatility ETFs offer investors another way to dampen anxiety in today’s schizophrenic stock market.