Prices change when events are different from what the market expected them to be. -Peter Bernstein
Generating long-term wealth is an art that requires investors to deftly juggle attack and defense; I find that some of the younger players in the market sometimes tend to be overly short-sighted, focusing only on circuits, while paying little attention to building some kind of defensive shield when the going gets tough.
The Invesco S&P 500 Low Volatility ETF (NYSEARCA:SPLV) appears to be a vehicle that has the necessary ingredients to help investors weather difficult market conditions. It’s a popular defensive product (having amassed nearly $9 billion in assets under management over nearly 11 years) that focuses on 100 S&P 500 stocks that have shown the lowest realized volatility over the course of of the past 12 months (weights are based on the inverse of each security’s volatility, with the least volatile securities receiving the highest weights). You have in front of you a fairly updated portfolio as it is replenished and rebalanced four times a year, and the most recent exercise was only last month.
We have already seen the utilitarian qualities of this ETF come to the fore this year; it is well documented that 2022 has not been a particularly serene year for the markets. On a YTD basis, the VIX is up around 37%; Interestingly, during this period we have seen the traditionally popular growth segment of the S&P 500, represented by the Invesco S&P 500 High Beta (SPHB) ETF, lose its AUM by an identical percentage. Meanwhile, our defensive vehicle – SPLV, although not tearing down any trees, saw its AUM maintained for the same period.
The useful qualities of SPLV in an environment like this can also be viewed over a much longer period and will give you an idea of the type of product you are looking for. If you consider a 10-year look-back period, note that SPLV’s annualized standard deviation of its monthly returns is only about half that of SPHB. Also crucially note SPLV’s superior Sortino ratio, which gives you an idea of an ETF’s ability to juggle downside deviation, or harmful volatility, in its quest to generate excess returns. Also note that the maximum drawdown with the low-beta cohort of SPLV was much less pronounced than SPHB.
Then I recognize that you won’t quite get the breakneck profit growth boost that SPHB Constituents can offer you, but I don’t think you can dismiss the income-generating qualities of some of the top holdings. of SPLV, which will serve as a very useful cushion during choppy market environments or prolonged pullbacks.
For example, consider SPLV’s top holdings; With the possible exception of The Hershey Co., all of these other stocks currently offer futures yields above the median of the sector to which they belong (the variance of Procter & Gamble (PG) is hardly significant).
SPLV is dominated by two sectors in particular; utilities which represent ~24% of the total portfolio and consumer staples which represent 23% of the total portfolio. As noted in the Leaders/Laggers section of the Lead-Lag report (where I compare various market segments to the SPY), long-term conditions for these two sectors look relatively healthy.
Subscribers to the Lead-Lag Report would recognize that I use a series of time-tested inter-market signals to gauge relative volatility conditions, and based on these signals, I advise investors to play the attack or the defense.
Now, even though 2022 has so far been quite difficult for equity investors to navigate, I continue to believe that a deeper risk environment is brewing, which could further increase the appeal of an SPLV. Why do I think so?
Well, consider the economic outlook, which is expected to deteriorate in the coming months; GDP forecasts for the first quarter quickly fell from 3% at the start of the year to something between 1.3% and 1.7%. It also makes the IMF’s 4% forecast for the fiscal year particularly outlandish. As noted in the recent edition of the Lead-Lag report, I also don’t think you can be particularly calm about growth expectations when the Fed appears to be acting quite aggressively with rates. Powell hinted that the Fed will likely only commit to quarter-point rate hikes at each of the remaining Fed meetings this year, but clearly the futures market isn’t buying that. , and rather, what you’re looking at is, 40% expect us to get 50 basis point hikes in May and June (Governors like Governor Bullard and Waller have also postulated this).
Tighter monetary conditions and slower growth is just the right concoction for recession risks to rise and you see that reflected in bond market trends where the Treasury yield curve is flattening, and we are not too far off to see the 10Y/2Y reversal.
Finally, also note the possibility of mean reversion with something like SPLV, as investors potentially turn away from SPHB. Currently, the relative strength ratio of SPLV vs. SPHB seems quite outside the normalized range, and that might entice defensive-minded value hunters to join us.
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