Stock investors have enjoyed near-perfect market conditions for months. The economy is growing steadily. Inflation is under control. The artificial intelligence (AI) boom is still fueling markets. And volatility has been relatively low.
It's easy to forget that conditions aren't always like this. Sometimes the markets get rattled and investors are suddenly looking at losses in their portfolios. This can lead to impulsive or emotionally charged decision-making, which almost always results in damaged long-term returns.
The solution is to build your portfolio to help withstand those inevitable downturns. Holding some defensive equity positions in your portfolio can help smooth out some volatility while maintaining the overall growth potential that comes from investing in stocks.
One really good fund to consider for this is the iShares MSCI USA Minimum Volatility Factor ETF (USMV +0.36%).
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What is the iShares MSCI USA Minimum Volatility Factor ETF?
According to the iShares website, this fund tracks an index of U.S. equities that, in the aggregate, have lower volatility characteristics relative to the broader U.S. equity market.
The "in the aggregate" part of the objective is an important distinction to clarify. It's not merely a collection of stocks with below-average volatility. The Minimum Volatility ETF instead starts with a broad universe of large-cap and mid-cap U.S. stocks and then optimizes it to produce the "lowest absolute volatility."
That means as long as the optimized portfolio of securities can demonstrate lower risk overall and the diversification factor can help mitigate some additional volatility, it's not constrained by what it can own.
NYSEMKT: USMV
Key Data Points
Minimum volatility vs. low volatility
The natural comparison to this fund might be the Invesco S&P 500 Low Volatility ETF (SPLV +1.25%), a fund that only selects stocks that exhibit below-average volatility.
The Low Volatility ETF produces the portfolio that you might expect. Its top three sector holdings are utilities (21.4%), financials (19%), and consumer staples (13.7%). All of these are relatively defensive sectors that are designed to hold up better when the market heads lower. There's certainly nothing wrong with holding this type of fund to help provide some downside protection.
But compare that to how the Minimum Volatility ETF looks.
Its top three sector holdings are technology (29.7%), healthcare (15%), and financials (14.5%). Nvidia is one of its top 10 holdings. It's counterintuitive to think that this kind of strategy could hold such a large proportion of its portfolio in tech stocks. But that's the advantage of minimum volatility versus low volatility.
As long as it works within the framework of minimizing total portfolio volatility, it can hold securities that may have higher individual volatility. It allows for the capture of growth opportunities that a traditional low volatility strategy may screen out. But it still delivers on its volatility mitigation strategy.
The Minimum Volatility ETF has a 10-year portfolio beta of 0.93 and a standard deviation of returns of 12.23%. The Low Volatility ETF has a beta of 1.0 and a standard deviation of returns of 12.53%. On top of that, the Minimum Volatility ETF has outperformed over that 10-year time frame. Its ability to reduce risk and deliver above-average returns shows that managing risk at the portfolio level instead of the individual security level can be better for long-term results.
Why minimum volatility is a smart strategy for uncertain markets
A minimum volatility strategy can give you the best of both worlds. It can provide a degree of downside protection in falling markets, but still give you exposure to some of the better growth opportunities in the market. The Minimum Volatility ETF has beaten the Low Volatility ETF by an average of 1.8% per year over the past decade.
If you're looking for a fund to help mitigate portfolio volatility during uncertain times yet still provide exposure to the market's higher growth opportunities, the iShares MSCI USA Minimum Volatility Factor ETF is one of the best plays available.
