Investors looking to avoid volatile markets are turning to low-volatility funds. The Franklin International Low Volatility High Dividend Index ETF (LVHI) also has the added bonus of generating income. Morningstar gives the fund a five-star rating for its “strong long-term risk-adjusted performance.” LVHI has $4 billion in assets under management, a 30-day SEC yield of 3.35%, and an expense ratio of 0.40%. Low-volatility funds generally seek to smooth out the ride for investors by owning stocks with small price fluctuations. This means that performance may decline when the market is rising. Not so this year. As of midday Friday, LVHI is up about 8% year-to-date, excluding dividends, while the S&P 500 is down nearly 7%. All three major indexes fell on Friday, with the Dow Jones Industrial Average at one point down 10% from its recent high, but strictly speaking it was a correction. “This is a great strategy that people turn to when there’s a lot of turmoil,” said Jeff Silverman, head of advisory solutions at Franklin Templeton Investment Solutions. Since January 1, about $469 million has flowed into the ETF. International Diversification Diversification is also very important these days. LVHI earns it through international equities while hedging currency exposure to further reduce volatility. “These stocks may be driven by different economic forces than traditional domestic stocks,” Silverman said. International stocks “have a low correlation to growth and tend to be more defensive than traditional value strategies.” This ETF is rules-based. That is, rather than tracking an index (in the case of LVHI, MSCI World ex US Index) when choosing investments, you follow the rules of the index. The manager performs a screening, starting with approximately 3,000 of the largest international developed stocks. First, we look for high-dividend companies or companies whose earnings exceed their dividends. Next, we test whether volatility is low by measuring the volatility of price and earnings. Managers end up choosing from a pool of approximately 150-200 stocks. “If you’re just looking for high dividends and avoiding fluctuations in price and earnings, you could be missing something, because high volume could mean something is going on that makes the dividend unsustainable,” Silverman said. As a result, we are now overweight in energy stocks, consumer staples, and utilities. “These work very well in times of turbulence. Money flows from there and flows to more defensive locations,” he said. “Even in times of economic weakness, an overweight in utilities would do very well.” Domestic Options Another domestic option is the Franklin U.S. Low Volatility High Dividend Index ETF (LVHD). Its investment scope is limited to the Russell 3000 Index. The domestic ETF has a 30-day SEC yield of 3.26% and an expense ratio of 0.27%. It’s also up 6.6% since the beginning of the year, outperforming the broader market. Major holdings include Verizon Communications, Chevron, and American Electric Power. Role Cage Both funds should be considered conservative core holdings in a portfolio, regardless of market volatility, Silverman said. He said ETFs can balance out “higher octane exposure” like tech stocks and could act as a risk mitigation solution. He likens it to driving a race car with stronger seat belts and a roll cage for added protection. “That portfolio also needs to include things like ballast and safety equipment, so roll cages,” Silverman said. “As investors, we cannot control returns,” he added. “Returns are random based on the economic regime and its transitions, but what we can control is the volatility of the portfolio.”
