As baby boomers strive to generate healthy investment returns for retirement, while also seeking to preserve their capital, low volatility exchange-traded funds (ETFs) are proving to be effective tools that can help these clients meet their goals.
“The biggest concerns of retiring or aging clients are to create an income stream from their investments and protect capital,” says Kevin Gopaul, chief investment officer at Bank of Montreal Exchange-Traded Funds in Toronto. “Low volatility ETFs focus on downside protection and capital preservation, and the low beta story resonates with investors.”
Low volatility ETFs typically produce healthy returns but with lower volatility than market indices, due to concentration in their underlying portfolios on stocks that fluctuate less than average. This concept has been particularly appealing to investors given the higher-than-average market volatility in recent years.
“Some people are afraid of equity markets after having a negative experience,” says Mary Anne Wiley, managing director of BlackRock Asset Management Canada Ltd. and head of iShares Canada. “We’ve seen strong growth in our family of low volatility products, which are designed to dampen the peaks and valleys of the rollercoaster ride.”
Global equity markets have advanced significantly since the market crash of 2008-09. The S&P 500, for instance, has more than doubled, including dividends, from its low point of 2009.
However, the outlook for equities is clouded by a variety of risks, including a potential earnings slowdown, the effects of reduced government stimulus measures, and slowing economic growth in China.
Low volatility ETFs could potentially soften the blow in the event that such risks materialize. Although the products are relatively new to the market, back-testing — which is purely theoretical and not based on actual results — shows they would have outperformed a traditional index during the past 10 years.
“Low volatility is the new black,” says Michael Cooke, head of distribution for Toronto-based PowerShares Canada. “The low volatility products can reduce risk for those concerned about a correction, given that we are in the fourth year of an equity rally, or for fixed-income investors moving into equity.”
Whether the same strategy can outperform during the next 10 years is unknown, as many traditionally stable stocks, such as utilities and other high-dividend stocks, have become popular and more expensive, and therefore more vulnerable to downside risk.
A handful of providers offer low volatility products in Canada, including BMO ETFs, PowerShares Canada (a division of Invesco Canada Ltd.) and BlackRock Asset Management Canada’s iShares division.
BMO was first in the low vol market, launching BMO Low Volatility Canadian Equity ETF in October 2011, which has grown to $120 million in assets. BlackRock iShares has the broadest selection, with five low vol ETFs launched in July 2012, which are now cornering about $85 million in assets.
The iShares ETFs focus on geographically diversified indices, including MSCI USA Minimum Volatility, MSCI Canada Minimum Volatility, MSCI Emerging Markets Minimum Volatility, MSCI EAFE Minimum Volatility and MSCI All Country World Minimum Volatility.
BMO recently launched a U.S. low volatility ETF in both a hedged and unhedged version, and PowerShares offers two low vol ETFs, based on selected stocks within the S&P 500 and the S&P/TSX Composite Index.