Low volatility exchange traded funds (ETFs) are designed to protect you from bumps in markets like those experienced over the past month and they seem to have proved their mettle during last month's market falls.
Every low volatility ETF listed on the London Stock Exchange has beaten its plain vanilla counterpart over the course of the three-month market rout triggered by the Chinese stock falls, one of the biggest tests for these funds to date. All five ETFs analysed delivered less volatile returns than their conventional counterparts on a weekly basis since the start of the crash at the beginning of July and 1 September 2015.
Ossiam FTSE 100 Minimum Variance UCITS ETF (UKMV) and SPDR S&P 500 Low Volatility ETF (USLV) were among the best at protecting investors. On a weekly basis between 1 July and 1 September, the Ossiam ETF has a volatility measure of 1.92 per cent, lower than the FTSE 100 at 2.62 per cent, and SPDR's original S&P 500 UCITS ETF (SPY5) scores 2.68 per cent which makes it more volatile than its low volatility offering at 1.37 per cent.
The peak to trough falls delivered by the European, global and FTSE ETFs was also more moderate in the low volatility group. iShares Core MSCI World UCITS ETF (SWDA) scored a weekly maximum drawdown, the distance between the weekly peak to troughs, of 7.32 per cent, compared to its minimum volatility peer which scored 3.69 per cent. The same was true of SPDR S&P 500 Low Volatility, with a maximum drawdown of 3.13 per cent compared with more than double that figure for its original peer.
Finally measures of downside risk - the risk of an ETF falling fast in a bad market - also put low volatility ETFs in a more favourable position.
Less volatile returns do not necessarily mean better returns. But the low volatility ETFs also win on that basis, generally losing less than their conventional counterparts over a one- and three-month basis.
How they achieve their returns
iShares and Lyxor offer low volatility global equity ETFs, and iShares also has European and Emerging market equity options. Both providers' low volatility indices take the least volatile stocks based on how those stocks' returns vary from their average over time, known as standard deviation data. This means that their low volatility ETFs, including the iShares MSCI World Minimum Volatility (MINV) and iShares S&P 500 Minimum Volatility (MVUS) funds, are skewed towards more defensive sectors. For example, iShares Core MSCI World UCITS ETF's largest holding is Apple (US: AAPL), whereas its low volatility version's largest holding is McDonalds (US: MCD).
Ossiam is the only provider to have listed a minimum variance FTSE 100 ETF on the London Stock Exchange. Its minimum variance method selects the least volatile stocks and then looks at the correlations between them in the portfolio. It claims this creates the least volatile portfolio as a whole.
The data explained ■ Volatility (weekly): a measure of variation from mean returns - ie an ETF which returned 3 per cent each week would have a standard deviation of 0. Takes data at close of business each Friday. ■ Maximum drawdown: the maximum loss from peak to trough before a new peak is attained. The larger the number the worse the result. ■ Downside risk: an estimate of an ETF's potential to suffer a decline in value if market conditions change. The larger the number, the worse the result. |
Volatility metrics and performance of low volatility ETFs compared with standard ETFs
| Minimum volatility ETFs and original ETF counterparts | Weekly volatility 1 July -1 Sep 2015 (%) | Weekly max drawdown 1 Jul - Sep 2015 (%) | Weekly downside risk 1 Jul - 1 Sep 2015 (%) | Cumulative returns 1m (%) |
| iShares MSCI World Minimum Volatility (MINV) | 1.5 | -3.7 | 2.2 | -2.0 |
| iShares Core MSCI World UCITS ETF GDP (SWDA) | 2.4 | -7.3 | 3.0 | -4.4 |
| iShares S&P 500 Minimum Volatility (MVUS) | 1.3 | -2.7 | 1.4 | -2.5 |
| iShares Core S&P 500 (CSP1) | 2.7 | -7.3 | 3.2 | -3.7 |
| iShares MSCI Europe Minimum Volatility (IMV) | 2.0 | -5.0 | 2.4 | -3.9 |
| iShares MSCI Europe (IMEA) | 2.5 | -7.3 | 3.3 | -5.4 |
| Lyxor UCITS ETF MSCI World Risk Weighted (WDRL) | 1.8 | -5.2 | 2.3 | -3.9 |
| Lyxor UCITS ETF MSCI World D (WLDL) | 2.0 | -6.6 | 2.3 | -4.5 |
| SPDR S&P 500 Low Vol (USLV) | 1.4 | -3.1 | 1.7 | -2.6 |
| SPDR S&P 500 UCITS ETF (SPY5) | 2.7 | -7.3 | 3.1 | -3.7 |
| Ossiam FTSE 100 Min Variance (UKMV) | 1.9 | -4.5 | 2.5 | -3.8 |
| FTSE 100 | 2.6 | -7.4 | 3.8 | -6.0 |
Source: FE Trustnet, as at 1 September 2015
