The race to declare dominance over a particular segment of the market is one that fund companies dream about. They work hard to conjugate unique strategies that stand above plain vanilla indexes in the hopes that their secret sauce adds a measure of value. While this year found many fundamental or “smart beta” ETFs at parity with their passive benchmarks, there were some select ETFs that were worth the added layer of sophistication.
Minimum volatility ETFs have become a mainstream alternative for core equity allocations among conservative ETF investors. The PowerShares S&P 500 Low Volatility Portfolio (SPLV) and iShares MSCI U.S. Minimum Volatility ETF(USMV) are both designed to select a subset of stocks with lower overall price fluctuations than their index peers. This leads to a smaller basket of stocks with reduced risk characteristics than a traditional broad-based fund.
This year, both SPLV and USMV have modestly outperformed the market-cap weighted SPDR S&P 500 ETF (SPY) by 2.5% on a total return basis. This is due in large part to overweight allocations in utilities, consumer staples, and health care sectors, which have been persistent market leaders in 2014. In addition, the comparative chart below shows how USMV had much lower overall drawdown in the October sell off than SPY. This ETF proved to effectively reduce drawdown as its investment mandate implies.
Another smart beta ETF showing a burst of relative strength is the First Trust Capital Strength ETF (FTCS). This fundamental index is constructed of 50 stocks with high cash reserves, low debt, and sturdy return on equity. Companies are selected and then ranked within the ETF by the lowest volatility with caps on individual sector and industry weightings. The end result is a value-oriented group of high quality stocks spread across multiple areas of the domestic market with an equal weighted asset allocation.
