Some funds of­fer to tame mar­ket’s chaos, at a price

The Denver Post - - BUSINESS - By Stan ChoeThe

Freaked out by the stock mar­ket’s big swings?

Then the in­vest­ment in­dus­try has some­thing it built just for you: funds that hope to of­fer a stead­ier ride. That sounds es­pe­cially com­fort­ing af­ter this year’s jar­ring start for mar­kets, in which drops of more than 1 per­cent have be­come typ­i­cal. But be care­ful, the funds carry risks.

Th­ese mu­tual funds and ex­change-traded funds own stocks that could char­i­ta­bly be de­scribed as bor­ing. Think util­i­ties, tele­coms and other com­pa­nies whose prof­its— and thus stock prices— don’t fluc­tu­ate so much. The funds avoid jackrab­bit stocks that tend to have ei­ther re­ally good or re­ally bad days.

Th­ese funds ad­ver­tise them­selves by in­clud­ing terms such as “low volatil­ity” or some­thing sim­i­lar in their names, and fund com­pa­nies have rolled out dozens of them in the past five years to meet strong de­mand.

The prob­lem, for now at least, is that the types of stocks th­ese funds own have un­cer­tain out­looks. Many are at risk of fall­ing if in­ter­est rates rise, and the ex­pec­ta­tion is for the Fed­eral Re­serve to con­tinue rais­ing its bench­mark rate. And many have been bid up to heights that look pretty thrilling for bor­ing com­pa­nies.

“You’ve got­ten to a point where they’re trad­ing at higher val­u­a­tions than a mar­ket that’s al­ready ex­pen­sive,” says Leuthold Group chief in­vest­ment of­fi­cer Doug Ram­sey.

Six years ago, an in­dex of the 100 least-volatile stocks in the S&P 500 was 13 per- cent cheaper than the broad in­dex. But at the start of this year, it was the mir­ror im­age. The S&P 500 Low Volatil­ity in­dex was 13 per­cent more ex­pen­sive than the S&P 500.

Many low-volatil­ity funds fo­cus on div­i­dend-pay­ing stocks, which tend to have stead­ier re­turns. The fear is that when rates rise, in­come in­vestors will go back to bonds and dump div­i­dend-pay­ing stocks.

“Ev­ery­one is in­vest­ing in stocks that look ‘low risk’ based on his­tory,” says Jim Fal­lon, who runs low-volatil­ity funds at MFS In­vest­ment Man­age­ment. “That leads to a lot of crowd­ing in this space.”

For ex­am­ple, Proc­ter & Gam­ble has been a rel­a­tively steady stock in part be­cause in­vestors think peo­ple will con­tinue buy­ing Bounty pa­per tow­els and Pam­pers di­a­pers even if the econ­omy falls into a re­ces­sion. But that has made it pop­u­lar— maybe too pop­u­lar. Its shares are trad­ing at nearly 30 times their earn­ings per share, close to the high­est level in 13 years. The S&P 500 trades at 16 times earn­ings.

That’s why Fal­lon is con­sid­er­ing stocks that ri­val low-volatil­ity funds may not be. For ex­am­ple, many funds in­vest in only the 10 or 20 per­cent of stocks that have had the mildest price swings in the S&P 500 or an­other in­dex over a cer­tain time pe­riod. At his MFS Low Volatil­ity Equity fund, Fal­lon con­sid­ers any stock as long as it’s in the bot­tom 60 per­cent of the 1,000 largest U.S. stocks in terms of volatil­ity.

The big­gest catch in low-volatil­ity in­vest­ing, Fal­lon says, lies in the time com­mit­ment. “You can’t put it in and pull it out if you’re dis­ap­pointed af­ter a year.”

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