The stock market has been on a wild ride over the past 12 to 14 months, and while it's up overall now, the volatility we've endured along the way has been a lot to bear for many investors. Certain sectors have fared poorly during the pandemic and recession, and some industries are facing material long-term changes as a result.
While it is important to keep in mind the short-term nature of volatility, many investors find they can sleep easier when their portfolios include diversified baskets of stocks in exchange-traded funds (ETFs). Here are two stock ETFs that seek to provide consistent returns with limited volatility.
Using factor investing to reduce volatility
Consider the SPDR MSCI USA Strategic Factors ETF (QUS 1.75%) -- its name may be a mouthful of acronyms, but they translate to an investment vehicle designed for low volatility. It tracks the MSCI USA Factor Mix A-Series Capped Index, which is an equal-weighted combination of three indexes -- the MSCI USA Value Weighted Index, the MSCI USA Quality Index, and the MSCI USA Minimum Volatility Index. Thus, it invests in large-cap and mid-cap companies that are screened for specific value, quality, and low-volatility characteristics.
This multifactor, smart-beta strategy seeks to bridge the gap between active and passive management. In other words, while the fund is still passively managed, its screens are designed to create a mix of high-quality and attractively valued stocks with relatively low volatility.
Its expense ratio of 0.15% is slightly higher than some of SPDR's other offerings, but still well below typical fees for actively managed funds.
The SPDR MSCI USA Strategic Factors ETF holds 620 stocks. Its largest positions are in Microsoft, Apple, and Johnson & Johnson. However, since it is a capped index, which ensures greater diversification, the biggest single position accounts for just 2.9% of the portfolio's value.
The ETF launched in April 2015 and has about $870 million in assets. Last year, it returned a solid 12.3%, which trailed the MSCI USA Index (the index for large- and mid-cap stocks). But its longer-term performances were better, with a three-year annualized return of 12.9% and a five-year annualized return of 14.3% through Dec. 31, 2020. The ETF has a short track record, but, as it showed in 2018 when it dropped less than the broad market in a down year, it is designed to limit downside risk and produce steadier, less volatile returns.
Seeking strong mid-cap stocks to fight volatility
The Franklin LibertyQ U.S. Mid Cap Equity ETF (FLQM 2.13%) is similar to the SPDR ETF in that it strives for low-volatility performance. It too tracks a multifactor index -- the FTSE Russell LibertyQ U.S. Mid Cap Equity Index, a proprietary index created for Franklin Resources by FTSE Russell. It is based on the Russell Midcap Index with stocks that meet certain standards on four characteristics -- quality, value, momentum, and low volatility. Specifically, the exposure is 50% quality, 30% value, 10% momentum, and 10% low volatility.
As it draws only from the mid-cap universe, the fund has fewer holdings than the SPDR ETF -- about 205. Beyond that, the screens, which are more heavily weighted to quality and value, produce a portfolio that's quite different than the SPDR ETF.
Its largest holdings include KLA, HP, and Discover Financial. The biggest of them represents 1.18% of the portfolio.
As mid-caps are typically more volatile than large-cap stocks, this portfolio has the potential to generate higher long-term returns while tamping down on volatility. Its record reflects that: With a return of 15.5%, the ETF slightly underperformed the Russell Midcap Index's 17.1% in 2020. However, its three-year annualized return of 12.6% beats the 11.6% annualized return of the Russell Midcap over that period. This ETF has a slightly higher expense ratio than the SPDR at 0.30%. And like the SPDR, it has a short track record.
Looking at the performance of these two ETFs in the most recent down periods for the markets, both beat their respective benchmarks in 2018 when the markets were in negative territory for the year. The SPDR ETF was down 3.65% for the year compared to -4.5% for the MSCI USA Index. The Franklin ETF was down 4.2% compared to the Russell Midcap Index, which was down 9.1%.
Be careful with these ETFs
Even though these ETFs try to clamp down on volatility, no investment always succeeds in doing so. During the coronavirus stock market crash in February and March 2020, both of these ETFs suffered drops in line with the overall market. They provided no real cushion compared to the broader market.
However, few bear markets have resembled what happened last year, so it's understandable that these ETFs got caught out. Overall, for investors who are concerned about volatile markets and seek more consistent returns, I think these are two solid choices.