SPLV - USMV: A Solid ETF For Volatility Reduction

2023-11-08 20:00:45 ET

Summary

• The iShares MSCI USA Min Vol Factor ETF seeks to track an index of U.S. equities with lower volatility characteristics than the broad market.
• USMV has a low management fee and has delivered very strong historical risk adjusted performance.
• USMV's investment approach appears to focus on overweighting more defensive sectors as well as overweighting more defensive stocks within each sector.
• Investors looking for a way to reduce volatility should consider USMV as an attractive alternative to broad market indexes.

ETF Overview

The iShares MSCI USA Min Vol Factor ETF ( USMV ) seeks to provide investors with results that track an index composed of U.S. equities that, in aggregate, have lower volatility characteristics relative to the broader U.S. equity market.

USMV has ~$28 billion in net assets and charges an expense ratio of 0.15%. Fund characteristics currently include 168 holdings, a trailing P/E ratio of 22.2x, a 12m trailing yield of 1.84%.

Index Construction Methodology

In order to get a sense of how exactly the MSCI USA Min Vol Index is constructed, we can look to USMV's prospectus which states:

In constructing the Underlying Index, MSCI uses a rules-based methodology to select securities from the MSCI USA Index (the "Parent Index"), which is a capitalization-weighted index, and to determine the weightings of such securities in the Underlying Index. Under the rules-based methodology, securities and weightings of the Underlying Index are determined based on pre-established parameters and discretionary factors are not relied on.

Generally, the rules-based methodology includes specified requirements for security eligibility, maximum and minimum weightings by security and, in some cases, by sector and country, as well as rules for special dividends and other distributions and the treatment of corporate events. In order to determine weightings of securities within the Underlying Index, MSCI seeks to optimize the Parent Index such that the resulting portfolio exhibits the lowest absolute volatility, as measured by MSCI, while applying constraints based on turnover, established minimum and maximum weightings of index constituents and sectors, as well as factor constraints (for example, liquidity and financial leverage) as measured by MSCI.

The Underlying Index includes large and mid-capitalization companies and may change over time.

While we do not know the exact methodology MSCI uses to construct the index we do know that the index is dynamic and changes over time based on the performance of companies in the MSCI USA Index.

Management Fee

USMV has a fairly reasonable expense ratio of 0.15%. To put that into context, the average equity ETF expense ratio is ~0.16%. Moreover, USMV has an attractive expense ratio compared to other low volatility funds. The Invesco S&P 500 Low Volatility ETF ( SPLV ) has a total expense ratio of 0.25% while the Franklin U.S. Low Volatility High Dividend Index ETF ( LVHD ) has a total expense ratio of 0.27%.

Strong Historical Risk Adjusted Performance

USMV launched in October 2011 and underperformed the S&P 500 on an absolute basis but has performed well on a risk adjusted basis. Since inception, USMV has delivered a total return of 267.1% compared to 345.5%. USMV has significantly outperformed its peer SPLV which returned 222.2% over the same time period.

However, USMV has achieved this level of performance with an average historical 3 year trailing beta of 0.73. USMV has delivered an average 30 day rolling volatility of 11.64% compared to 14.53% for the S&P 500.

USMV has delivered an average 3yr trailing sharpe ratio of 1.16 vs 1.05 for the S&P 500.

Taken together, I believe these data points suggest that USMV has done a very good job of meeting its objective to deliver lower volatility than the broader U.S. equity market. Additionally, USMV has done this in a very efficient way as its realized average sharpe ratio since inception has exceeded the S&P 500.

Holdings Analysis

USMV is fairly well diversified with 168 holdings. The funds top holding is Eli Lilly ( LLY ) which accounts for just over 2% of the fund. The top 5 holdings account for just 8.8% of the fund. Comparably, the top 5 holdings in the S&P 500 account for ~23% of the index.

In regards to sectors, as shown by the table below, USMV has relatively large overweights in health care, utilities, and consumer staples. This is not surprising given that these sectors tend to be less cyclical and thus less volatile. USMV has large underweights in tech, consumer discretionary, and communications.

Based on this analysis, it is clear that USMV has two approaches to reduce volatility. The first is to overweight less volatile sectors. The second is to change the weights within sectors to favor less volatile securities. IBM ( IBM ) is the largest tech holding and the largest industrial holdings are waste collection companies Republic Services Inc ( RSG ) and Waste Management ( WM ).

This dual approach to volatility reduction appears to be working well for USMV based on strong historical risk adjusted performance.

Conclusion

In a world where many new ETFs have come to market offering very high fees for products that fail to deliver, USMV stands out as a solid ETF which has delivered on its investment objective.

USMV charges a relatively low management fee and follows an investment approach which has delivered below market volatility in an efficient way.

USMV offers investors an efficient way to reduce volatility and has potential to play an effective role in the portfolio construction process for investors seeking lower risk equity exposure.

Past performance is not a guarantee of future performance so investors should continue to monitor USMV going forward to ensure it is delivering strong risk adjusted returns that are inline with broad market indexes.

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