Some funds of­fer smoother ride for in­vestors in shaky times

The Oklahoman (Sunday) - - BUSINESS - BY STAN CHOE AP Busi­ness Writer

While the stock mar­ket was busy heav­ing up and down in re­cent months, some funds were of­fer­ing a stead­ier, slightly less­nau­se­at­ing ride.

"Low-volatil­ity" funds cater to skit­tish in­vestors who have less tol­er­ance for tur­bu­lent mar­kets. These funds gen­er­ally re­strict them­selves to stocks with the mildest swings his­tor­i­cally, and sev­eral have lived up to ex­pec­ta­tions by drop­ping less than broad in­dex funds since the mar­ket turned choppy in early Fe­bru­ary.

"They have de­liv­ered what you would ex­pect them to pro­vide," said Alex Bryan, di­rec­tor of pas­sive strate­gies at Morn­ingstar. "These are most ap­pro­pri­ate for more risk-averse in­vestors" who might be tempted to sell dur­ing a down mar­ket — a no-no for long-term in­vest­ing.

No in­vest­ment is per­fect, of course. Lowvolatil­ity funds lagged S&P 500 in­dex funds in 2017, when big swings were rare and the mar­ket rode a pow­er­ful surge higher. Another risk lies in the ar­eas of the mar­ket that low-volatil­ity funds tend to fa­vor. Many have loaded up on the kinds of stocks that may be hurt most if in­ter­est rates keep ris­ing, as many on Wall Street ex­pect.

For now, though, in­vestors can ap­pre­ci­ate the slightly smoother ride. Since S&P 500 in­dex funds set a record high on Jan. 26, they've lost about 8 per­cent due to a com­bi­na­tion of fears about a pos­si­ble trade war and a more ag­gres­sive Fed­eral Re­serve. At one point, S&P 500 funds were down more than 10 per­cent from their peak, some­thing that in­vestors haven't had to deal with in about two years.

Over the same time, though, the iShares Edge MSCI Min Vol USA ETF is down a more mod­est 6.1 per­cent. The Pow­erShares S&P 500 Low Volatil­ity Port­fo­lio ETF, another one of the largest funds in the cat­e­gory by as­sets, is down only 5.3 per­cent.

Mod­est losses, mod­est gains

In gen­eral, ex­perts says, in­vestors in low-volatil­ity funds can ex­pect more muted losses in down mar­kets but also more mod­est gains dur­ing up mar­kets, lead­ing to roughly com­pa­ra­ble re­turns over the long term.

Low-volatil­ity funds take dif­fer­ent ap­proaches, but they gen­er­ally fo­cus on stocks that have a record of milder swings than the rest of the mar­ket.

The Pow­erShares S&P 500 Low Volatil­ity Port­fo­lio ETF, for ex­am­ple, tracks an in­dex that holds only the 100 stead­i­est stocks in the S&P 500, as mea­sured by their volatil­ity over the past 12 months. It re­jig­gers its port­fo­lio ev­ery three months, and its big­gest in­vest­ments cur­rently in­clude giants in the con­sumer sta­ples sec­tor, such as Coca-Cola and Pep­siCo, along with big util­i­ties like Duke En­ergy of Char­lotte, North Carolina.

This kind of ap­proach homes in on the stead­i­est stocks, but it can also mean con­cen­tra­tions in cer­tain swathes of the mar­ket. Nearly a quar­ter of the ETF is in util­ity stocks, for ex­am­ple. Util­i­ties make up less than 3 per­cent of S&P 500 in­dex funds.

The iShares Edge MSCI Min Vol USA ETF tries to mit­i­gate that by fol­low­ing an in­dex that can limit how big sec­tors get in the port­fo­lio. Util­ity stocks make up 7 per­cent of its in­vest­ments, for ex­am­ple. Its big­gest in­vest­ments in­clude Visa, McDon­ald's and John­son & John­son.

Util­i­ties and stocks in the con­sumer sta­ples sec­tor gen­er­ally have his­to­ries of stead­ier price move­ments, and they also tend to pay higher div­i­dends than the rest of the mar­ket. Those stocks have been par­tic­u­larly at­trac­tive in re­cent years, when in­ter­est rates were close to record lows and bonds were pay­ing scant amounts of in­ter­est.

But in­ter­est rates have been on the rise. The Fed­eral Re­serve is grad­u­ally rais­ing short-term in­ter­est rates and par­ing back its bond in­vest­ments. A 10-year Trea­sury note has a yield of nearly 2.80 per­cent, up from 2.36 per­cent a year ago.

Un­der­cut­ting util­i­ties

Higher rates make bonds more at­trac­tive and un­der­cut de­mand for util­i­ties and high-div­i­dend stocks. That's part of the rea­son low-volatil­ity funds have had days dur­ing the re­cent volatil­ity where they've fallen more than the rest of the mar­ket.

On Feb. 21, for ex­am­ple, when bond yields jumped fol­low­ing the re­lease of min­utes from a Fed meet­ing, the Pow­erShares S&P 500 Low Volatil­ity Port­fo­lio ETF lost 0.8 per­cent. S&P 500 in­dex funds lost 0.5 per­cent the same day.

Be­cause their prices can be so sen­si­tive to in­ter­est rates, strate­gists at Black­Rock gen­er­ally pre­fer stocks out­side what they call the "RUST" belt of real es­tate, util­i­ties, sta­ples and tele­coms — where low-volatil­ity funds tend to have big­ger con­cen­tra­tions than S&P 500 in­dex funds. In­stead of stocks where div­i­dends are sim­ply high, the Black­Rock strate­gists pre­fer ar­eas where div­i­dends are grow­ing, such as in the tech­nol­ogy and bank­ing in­dus­tries.

Re­gard­less of any un­der­per­for­mance lowvolatil­ity funds may have in the short term, in­vestors need to be will­ing to hold onto them for years, said Morn­ingstar's Bryan.

"We think these are good ideas for long-term in­vest­ment," he said. "But if you get frus­trated eas­ily by un­der­per­form­ing the mar­ket, these aren't for you be­cause they're go­ing to go through mul­ti­year dry spells."

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