Tag Archives: etfs

Stocks That Can Double, Can Give You Trouble

Summary Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Fourth, for the few that rise a lot, you can’t invest in them. I haven’t written about promoted penny stocks in a long time . Tonight, I am not writing about promoted stocks, only penny stocks as promoted by a newsletter writer . He profits from the newsletter. Ostensibly, he does not front-run his readers. Before we go on, let me run the promoted stocks scoreboard: Ticker Date of Article Price @ Article Price @ 12/1/15 Decline Annualized Dead? ( OTCPK:GTXO ) 5/27/2008 2.45 0.011 -99.6% -51.5% ( OTCPK:BONZ ) 10/22/2009 0.35 0.000 -99.9% -68.5% ( OTCPK:BONU ) 10/22/2009 0.89 0.000 -100.0% -100.0% ( OTC:UTOG ) 3/30/2011 1.55 0.000 -100.0% -100.0% Dead (OBJE) 4/29/2011 116.00 0.000 -100.0% -100.0% Dead ( OTCPK:LSTG ) 10/5/2011 1.12 0.004 -99.6% -74.2% ( OTC:AERN ) 10/5/2011 0.0770 0.0001 -99.9% -79.8% ( OTC:IRYS ) 3/15/2012 0.261 0.000 -100.0% -100.0% Dead ( OTCPK:RCGP ) 3/22/2012 1.47 0.180 -87.8% -43.4% ( OTCQB:STVF ) 3/28/2012 3.24 0.070 -97.8% -64.7% ( OTCPK:CRCL ) 5/1/2012 2.22 0.001 -99.9% -87.2% ( OTCPK:ORYN ) 5/30/2012 0.93 0.001 -99.9% -85.4% ( OTCQB:BRFH ) 5/30/2012 1.16 1.000 -13.8% -4.1% ( OTCPK:LUXR ) 6/12/2012 1.59 0.002 -99.9% -86.3% ( OTCQB:IMSC ) 7/9/2012 1.5 0.495 -67.0% -27.9% ( OTCPK:DIDG ) 7/18/2012 0.65 0.000 -100.0% -100.0% ( OTCQB:GRPH ) 11/30/2012 0.8715 0.013 -98.5% -75.4% ( OTCPK:IMNG ) 12/4/2012 0.76 0.012 -98.4% -75.0% ( OTCPK:ECAU ) 1/24/2013 1.42 0.000 -100.0% -94.9% ( OTCPK:DPHS ) 6/3/2013 0.59 0.005 -99.2% -85.5% ( OTC:POLR ) 6/10/2013 5.75 0.005 -99.9% -94.2% ( OTC:NORX ) 6/11/2013 0.91 0.000 -100.0% -97.5% ( OTCQB:ARTH ) 7/11/2013 1.24 0.245 -80.2% -49.3% ( OTCPK:NAMG ) 7/25/2013 0.85 0.000 -100.0% -100.0% ( OTCPK:MDDD ) 12/9/2013 0.79 0.003 -99.7% -94.5% ( OTCPK:TGRO ) 12/30/2013 1.2 0.012 -99.0% -90.9% ( OTCQB:VEND ) 2/4/2014 4.34 0.200 -95.4% -81.6% (HTPG) 3/18/2014 0.72 0.003 -99.6% -95.9% ( OTCQB:WSTI ) 6/27/2014 1.35 0.000 -100.0% -99.9% (APPG) 8/1/2014 1.52 0.000 -100.0% -99.8% (CDNL) 1/20/2015 0.35 0.035 -90.0% -93.1% 12/1/2015 Median -99.9% -87.2% If you want to lose money, it is hard to do it more consistently than this. No winners out of 31, and only one company looks legit at all – Barfresh ( OTCQB:BRFH ). But what of the newsletter writer? He seems to have a couple of stylized facts that are misapplied. Every day, around 45 stocks double or more in price. Some wealthy investors have bought stocks like these. Wall Street firms own these stocks but never recommend them to ordinary individuals The media censors price information about these stocks so you never hear about them Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Of the 30 stocks mentioned above that were not dead at the time of the last article, 10 fell more than 90% over the 10+ month period. 13 fell less than 90%, 1 broke even, and 7 rose in price. The median stock fell 61%. This was during a bull market. Now you might say, “Wait, these are promoted stocks, of course they fell.” Only the last one was being actively promoted, so that’s not the answer. My fourth point is for the few that rise a lot, you can’t invest in them. The stocks that double or more in a day tend to be the smallest of the stocks. Two of the 30 stocks listed in the scoreboard rose 900% and 7100% in the 10+ month period since my last article. How much could you have invested in those stocks? You could have bought both companies for a little more than $10,000 each. Anyone waving even a couple hundred bucks could make either stock fly. So, no, these stocks aren’t a road to riches. Now the ad has stories as to how much money people made at some point buying the penny stocks. The odds of stringing several of these successful purchases in succession, parlaying the money into bigger and bigger stocks that double is remote at best, and your odds of losing a lot of it is high. This idea is a less classy version of the idea promoted in the book 100 to 1 in the Stock Market . If it is difficult to find the 100-baggers 30 years in advance, it is more difficult to find a stock that is going to double or more tomorrow, much less a bunch of them in succession. You may as well go to Vegas and bet it all on Double Zero on the roulette wheel four times in a row. The odds are about that bad, as trying to get rich buying penny stocks. The ad also lists three stock that at some point fit his paradigm – MeetMe (NASDAQ: MEET ), PlasmaTech Biopharmaceuticals, Inc. (PTBI), which is now called Abeona Therapeutics Inc. (NASDAQ: ABEO ), and Organovo (NYSEMKT: ONVO ). All of these are money-losing companies (MeetMe may be breaking into profitability now) that have survived by selling shares to raise cash. The stocks have generally been poor. Have they had volatile days where the price doubled? At some point, probably, but who could have picked the date in advance, and found liquidity to do a quick in-and-out trade? The author lists five future situations as a “come on” to get people to subscribe. I find them dubious. As for wealthy investors, he mentions two: Icahn pulling of a short squeeze on Voltari (difficult to generalize from), and Soros with PlasmaTech Biopharmaceuticals, Inc. It should be noted that Soros has a big portfolio with many stocks, and that position was far less than 1% of his assets. In general, the wealthy do not buy penny stocks. As for brokers and the media not mentioning penny stocks, that is being responsible. The brokers could get in hot water for recommending or buying penny stocks even under a weak suitability standard. The media also does not want to be blamed for inciting destructive speculation. Retail investors lose enough money through uninformed trading, why encourage them to do it where fundamentals are typically quite poor. I’ve written two other pieces on less liquid stocks to try to explain the market better: On Penny Stocks and Good Over-the-Counter “Pink” Stocks . It’s not as if there isn’t value in some of the stocks that “fly under the radar.” That said, you have to be extra careful. Near the end of the ad, the writer describes how he is being extra careful also. Many of his rules make a lot of sense. That said, following those rules will get you boring companies that won’t double or more in a day. And that’s not a bad thing. Most significant money is made slowly – it doesn’t come in a year, much less in a day. That said, I recommend against the newsletter because of the way that it tries to attract people. The rhetoric is over the top, and appeals to those who sense conspiracies keeping them from riches, so join my club where I hand out my secret knowledge so you can benefit. In summary, as a first approximation, don’t invest in penny stocks. The odds are against you. Fools rush in where angels fear to tread. Don’t let greed get the better of you – after all, what is being illustrated is an illusion that retail investors can’t generally achieve. Disclosure: None

Flatter Yield Curve, Narrow Stock Leadership Forewarn Extreme Risk Takers

Summary How confident should diversified investors be that U.S. stocks can power ahead without the extraordinary stimulus of quantitative easing (QE) and zero percent interest rate policy? Not too confident. Some folks are glad to see seven years of extraordinary accommodation come to an end. Understanding late-stage bull market phenomena help tactical asset allocators monitor changes in risk-taking. Here are two gauges of “risk off” behavior that I am watching. How confident should diversified investors be that U.S. stocks can power ahead without the extraordinary stimulus of quantitative easing (QE) and zero percent interest rate policy (ZIRP)? Not too confident. Stocks that trade on the New York Stock Exchange are down roughly 7.0% from their May highs and down nearly 3.5% since the last QE asset purchase by the Federal Reserve occurred on December 18, 2014. Some folks are glad to see seven years of extraordinary accommodation come to an end. Consider Andrew Huszar. He is the former Fed official who managed the acquisition of $1 trillion in mortgage-backed debt, then subsequently condemned the endeavor in 2013. Huszar told CNBC, “[QE] pushed up financial asset prices pretty dramatically. A lot of that is the Fed pushing the market’s paper value way above it’s true value.” Is he wrong? Probably not. Metrics with the strongest correlation to subsequent 10-year returns – Tobin’s Q Ratio, P/E10, market-cap-to-GDP, price-to-sales – all suggest that current valuation levels are at extremes not seen since 2000 . Worse yet, if previous cycle extremes are any indication, one should be prepared for a 40%-50% bearish decline for popular benchmarks like the S&P 500. The typical argument against overvaluation – the “this time is different” argument – involves the assumption that unprecedented lows for interest rates render traditional valuation methodologies insignificant. There are at least two problems with this notion. First of all, for rates to stay this low well into the future, it would likely correspond to a feeble U.S. economy as well as anemic corporate revenue. (Corporate sales per share have already declined for three consecutive quarters.) It follows that a deteriorating fundamental backdrop would offset borrowing costs that remain low on a historical basis. The second trouble with pointing to low interest rates to dismiss overvalued equities? It ignores the directional shift from emergency level QE stimulus to zero percent policy alone to the highly anticipated quarter point tightening. Again, a diversified basket of equally-weighted stocks is down nearly 3.5% since the last QE asset purchase. (Review the NYSE chart above.) As always, overvaluation doesn’t matter until it does; exceptionally overpriced can become ludicrously overpriced for several years. On the other hand, understanding late-stage bull market phenomena help tactical asset allocators monitor changes in risk-taking. Here are two gauges of “risk off” behavior that I am watching: 1. Flattening Of The Yield Curve When spreads between longer and shorter treasury bond maturities rise, the yield curve steepens. Investors are less inclined to purchase long-dated treasury debt because they have faith in the strengthening of the economy. In contrast, when spreads fall, the treasury yield curve flattens. Investors demand the perceived safety of longer maturities because they are concerned that economic conditions are deteriorating. Now consider the current “risk off” behavior. One year ago, the spread between 10-years and 2-years chimed in at 1.8. Today it is roughly 1.3. The 2-year treasury bond yields have soared on the prospect of the Fed’s imminent rate hike, yet the 10-year yield has barely budged because investors are expressing concern about the potential for Fed policy error. Take a look at what transpired in the middle of 2012. The Federal Reserve met rapidly falling spreads head on, jolting “risk on” investing behavior via open-ended quantitative easing stimulus (QE3). Right now? Investors are exhibiting the kind of “risk off” preferences that transpired back in mid-2012. Yet the Fed is not gearing up to provide additional liquidity. On the contrary. Fed committee members seem resigned to raising borrowing costs, if ever so slightly. The narrowing between 30-year maturities and 2-years demonstrates a similar “risk off” pattern. The spread is even lower than when the Fed shocked and awed the investing world with QE3. The declining spreads and the flattening of the yield curve are a sign of risk aversion – one that, historically, has worked its way into stocks. If the current pattern of yield curve flattening continues, equity prices of popular benchmarks are likely to fall. 2. Narrowing of Stock Breadth According to Bespoke Research, the top 1% of Russell 3,000 stocks (30 largest) are up roughly 6.6% YTD. That is the top 1%. The other 99%? The remaining 99% of Russell 3,000 stocks have averaged a decline of -3.0% YTD. Others have identified the lack of participation using the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). The top 20 components have gained 59% while the other 480 components are collectively down 3.0% YTD. The result for the market-cap weighted ETF? A 3% gain. Historically, narrow breadth rarely bodes well for the intermediate- to longer-term well-being of market-cap weighted funds. A better picture of what is actually happening to risk preferences is evident in equal-weighted proxies like the Guggenheim Russell 1000 Equal Weight ETF (NYSEARCA: EWRI ). We can see that, much like the NYSE itself, EWRI is still close to 7% below its May high; EWRI is still trading at a lower price than when the Fed exited QE for good with its final mortgage-backed bond purchase on 12/18/2014. Similar to stock valuations, weak breadth may not matter until it does. Thin leadership where a few stocks carry the entire load can become even thinner leadership. Historically, however, the top 1% or the top 5% tend to buckle. That’s why it is sensible to ask one’s self, is it likely that the other 95% or the other 99% will join the top 1% or top 5% at extremely overvalued price levels? Or is it more likely that profit-taking on stocks like Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ) and Netflix (NASDAQ: NFLX ) will result in a take-down of the heralded S&P 500? For the majority of my moderate growth and income clients, I maintain a 60% stock (mostly large-cap domestic), 25% bond (mostly investment grade) and 15% cash/cash equivalent mix . This contrasts with a more typical “risk on” allocation of 65%-70% stock (e.g. large, small, foreign, etc.) 30%-35% bond (e.g. investment grade, convertible, high yield, foreign bond, etc.). Top stock ETF holdings include the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) , the Technology Select Sector SPDR ETF (NYSEARCA: XLK ) and the iShares Core S&P 500 ETF (NYSEARCA: IVV ). Top bond holdings include the Vanguard Total Bond Market ETF (NYSEARCA: BND ) as well as the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) . D isclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Low Vol U.S. Equity ETFs: 5 Risk Weighted Offerings

Summary This article examines 5 ETFs that strive to offer lower volatility and downside protection against the broad U.S. equity market. Each of the 5 ETFs considers prior volatility in selecting and weighting constituents. Three performance criteria and fees are analyzed. This article will examine 5 low/minimum volatility ETFs tracking indices whose goal is to create less risky portfolios in relation to their cap weighted equivalent. The way each underlying index builds a portfolio differs, but the common theme is that they use some measure of volatility as the sole basis for portfolio construction (with the exception of things like maximum weight for a stock and sector constraints). Selected constituents are then weighted based on their prior volatility, not their market cap. The recent market selloff of August and September provides us with some real life data for these funds. The oldest ETF discussed here is less than 5 years old, so real life data is limited. Although most of the underlying indices tracked go back farther, we will limit our analysis to their ETF manifestations and avoid back-tested un-investable indices. The following table introduces the ETFs with some basic information. They will be compared to the S&P 500, represented by the Vanguard S&P 500 ETF (NYSEARCA: VOO ). Name Ticker Inception AUM MER Vanguard S&P 500 ETF VOO September 7, 2010 $39.56 billion 0.05% PowerShares S&P 500 Low Volatility ETF SPLV May 5, 2011 $5.12 billion 0.25% iShares MSCI USA Minimum Volatility ETF USMV October 18, 2011 $6.82 billion 0.15% SPDR Russell 1000 Low Volatility ETF LGLV February 20, 2013 $30.16 million 0.12% iShares MSCI USA Size Factor ETF SIZE April 16, 2013 $201.90 million 0.15% Janus Equal Risk Weighted Large Cap ETF ERW July 29, 2013 $2.57 million 0.65% Source: Morningstar.com on November 27, 2015 A consideration of the methodologies and some basic portfolio characteristics will provide insightful background before we begin our analysis. The source for the methodology information is the respective ETF provider and underlying index provider websites. Vanguard S&P 500 ETF Methodology: The S&P 500 tracks 500 large U.S. companies that are weighted on a float-adjusted market cap basis. Probably the most popular benchmark in the world, we will use VOO as our benchmark and consider the ETFs in relation to it. Top Holdings Weight Apple Inc (NASDAQ: AAPL ) 3.70% Microsoft Corp (NASDAQ: MSFT ) 2.29% Exxon Mobil Corporation (NYSE: XOM ) 1.87% General Electric (NYSE: GE ) 1.59% Johnson & Johnson (NYSE: JNJ ) 1.52% Source: Morningstar.com on November 27, 2015 PowerShares S&P 500 Low Volatility ETF Methodology: The 100 stocks from the S&P 500 with the lowest standard deviation over the prior 252 trading days are weighted by the inverse of their volatility (lower volatility stocks get higher weights). Rebalancing and reconstitution occurs in February, May, August, and November. Top Holdings Weight Plum Creek Timber Co Inc (NYSE: PCL ) 1.26% Coca-Cola Co (NYSE: KO ) 1.26% Airgas Inc (NYSE: ARG ) 1.22% Clorox Co (NYSE: CLX ) 1.22% Waste Management Inc (NYSE: WM ) 1.16% Source: Morningstar.com on November 27, 2015 iShares MSCI USA Minimum Volatility ETF Methodology: Not much detail is given for the construction of the underlying MSCI index. We do know that the index is constructed using the proprietary Barra Optimizer to achieve the lowest absolute volatility with a certain set of constraints. The constraints include minimum and maximum constituent weights and sector weights relative to the original MSCI USA index. Rebalancing occurs in May and November. Top Holdings Weight McDonald’s Corp (NYSE: MCD ) 1.74% AT&T Inc (NYSE: T ) 1.66% Public Storage (NYSE: PSA ) 1.64% Paychex Inc (NASDAQ: PAYX ) 1.52% PepsiCo Inc (NYSE: PEP ) 1.49% Source: Morningstar.com on November 27, 2015 SPDR Russell 1000 Low Volatility ETF Methodology: Up to 200 stocks from the Russell 1000 with the lowest standard deviation over the past 252 trading days are weighted by the inverse of their volatility. Rebalancing occurs monthly. Top Holdings Weight Home Depot (NYSE: HD ) 2.17% Henry Schein Inc (NASDAQ: HSIC ) 2.10% Aflac Inc (NYSE: AFL ) 2.07% McDonald’s Corp 2.06% Travelers Companies Inc (NYSE: TRV ) 2.06% Source: Morningstar.com on November 27, 2015 iShares MSCI USA Size Factor ETF Methodology: This ETF tracks the MSCI USA Risk Weighted Index. The index considers the variance of the 3-year weekly historical local return of the MSCI USA Index. The weighting is computed as the ratio of the inverse of the security variance to the sum of the inverse of the security variances of all constituents in the parent index. Rebalancing occurs in May and November. Top Holdings Weight Synchrony Financial (NYSE: SYF ) 0.68% Chubb Corp (NYSE: CB ) 0.57% Arch Capital Group Ltd (NASDAQ: ACGL ) 0.53% Clorox Co 0.50% PepsiCo Inc 0.49% Source: Morningstar.com on November 27, 2015 Janus Equal Risk Weighted Large Cap ETF Methodology: Beginning with the S&P 500, stocks are weighted using a proprietary method such that the expected risk contribution of each stock is equal. Rebalancing occurs in January, April, July, and October. Top Holdings Weight Best Buy Co Inc (NYSE: BBY ) 2.43% L Brands Inc (NYSE: LB ) 1.67% Sysco Corp (NYSE: SYY ) 1.48% Motorola Solutions Inc (NYSE: MSI ) 0.88% Keurig Green Mountain Inc (NASDAQ: GMCR ) 0.86% Source: Morningstar.com on November 27, 2015 The sector makeup of the six ETFs differs substantially. Relative to the S&P 500, an underweight to energy and technology and overweight to basic materials, real estate, consumer defensive, and utilities are present in all of the low volatility ETFs. Sectors VOO SPLV USMV LGLV SIZE ERW Cyclical Basic Materials 2.79% 4.50% 3.46% 3.12% 4.43% 4.69% Consumer Cyclical 11.49% 3.10% 7.13% 5.89% 12.43% 18.55% Financial Services 14.97% 17.23% 10.75% 19.81% 18.85% 9.91% Real Estate 2.13% 6.71% 7.78% 12.75% 6.42% 4.61% Sensitive Communication Services 4.19% 4.10% 5.89% 5.82% 2.89% 2.42% Energy 7.11% 0.00% 2.52% 0.83% 3.60% 6.38% Industrials 10.96% 19.69% 9.44% 16.40% 14.02% 13.23% Technology 18.76% 0.00% 9.79% 5.68% 9.42% 11.51% Defensive Consumer Defensive 9.61% 20.13% 15.60% 11.97% 10.61% 11.54% Healthcare 15.05% 13.38% 19.80% 14.11% 9.78% 9.48% Utilities 2.93% 11.16% 7.84% 3.61% 7.54% 7.67% Source: Morningstar.com on November 27, 2015 The following holdings overlap matrix shows that these different approaches result in significantly different underlying holdings, even though the methodologies may seem similar. Holdings VOO SPLV USMV LGLV SIZE ERW VOO 100% 26% 38% 27% 50% 49% SPLV 26% 100% 43% 42% 29% 22% USMV 38% 43% 100% 35% 36% 25% LGLV 27% 42% 35% 100% 18% 12% SIZE 50% 29% 36% 18% 100% 66% ERW 49% 22% 25% 12% 66% 100% Source: ETF Research Center Overlap Analysis The correlation between them is noteworthy in that it is somewhat close to 1 with the exception of ERW. Correlation VOO SPLV USMV LGLV SIZE ERW VOO 1.00 0.85 0.93 0.90 0.96 0.33 SPLV 0.85 1.00 0.95 0.94 0.92 0.45 USMV 0.93 0.95 1.00 0.93 0.96 0.39 LGLV 0.90 0.94 0.93 1.00 0.94 0.46 SIZE 0.96 0.92 0.96 0.94 1.00 0.41 ERW 0.33 0.45 0.39 0.46 0.41 1.00 Source: Yahoo! Finance, monthly returns based on adjusted closing prices, 8/1/2013-10/31/2015 Evaluation Criteria Now that we have reviewed some of the basics, it is time to take a closer look at these ETFs in the context of past performance, with emphasis on their behavior in negative market periods. The measures chosen for evaluation are an attempt to answer the question: “What does an investor who chooses a low volatility fund care about?” The funds will be evaluated based on three performance criteria and their fees: Risk-adjusted returns relative to the S&P 500 as represented by VOO Up and down period performance relative to VOO Performance in periods where the S&P 500 faced a significant drawdown Fees Methodology: I used adjusted closing prices (adjusted for both dividends and splits) from Yahoo! Finance. Since this uses prices and not the NAV of the funds, I think it skews some of the results, mainly for the small and thinly traded ERW. With low volume, the underlying value of the fund’s holdings can deviate from its last traded price materially. This likely explains its low correlation to the other ETFs as well. Although prices describe the real investor experience, I would keep this in mind when evaluating the results, with particular emphasis on ERW. Criteria 1: Risk-adjusted returns relative to the S&P 500 as represented by VOO Low volatility ETFs should be held to a standard of exhibiting lower standard deviation than their relevant benchmark. However, the return side is important as well. If a fund produces low volatility but also low returns such that the risk-adjusted return is lower, the investor would have been better off holding the benchmark and some cash. We will divide the annualized return by the annualized standard deviation to determine risk-adjusted returns. This is essentially a Sharpe ratio, but ignores the risk free return because short term cash yields are so low (under 0.10% for 3 month T-bills for most of the period under examination). ETFs with a higher/lower value than VOO will receive a pass/fail on this criterion. VOO SPLV USMV LGLV SIZE ERW Return 11.72% 10.55% 12.51% 11.67% 11.50% 8.11% Std Dev 11.32% 10.42% 9.39% 10.53% 10.04% 7.62% Return/Std Dev 1.04 1.01 1.33 1.11 1.15 1.06 Result Fail Pass Pass Pass Pass Source: Yahoo! Finance, annualized monthly data based on adjusted closing prices, 8/1/2013-10/31/2015 Every fund exhibited lower standard deviation over the period examined. USMV even achieved higher returns, a nice bonus and a help in driving its return/standard deviation figure to be the highest of the bunch. Although SPLV managed a lower standard deviation than VOO, it was more than offset by its weaker performance. ERW is a concern here. The return of the fund is the lowest by far, and the only in single digits. In addition, its lack of trading volume has likely understated the true standard deviation of the NAV of the fund. The numbers say it still gets a pass, but extra caution should be placed on its results. Criteria 2: Up and down period performance relative to VOO This measure will provide detail on how the ETFs do in up and down periods. The ideal low volatility fund doesn’t go down very much in market declines but can hang in the market rallies. A passing grade will be given to a fund that outperforms in more than half of the months in which VOO had a negative return. The percentage outperformance in positive months for VOO will be presented as well, but will not be scored. Months SPLV USMV LGLV SIZE ERW Outperformance vs. VOO in up months 17 41% 35% 47% 41% 12% Outperformance vs. VOO in down months 10 80% 70% 80% 60% 100% Result Pass Pass Pass Pass Pass Source: Yahoo! Finance, monthly returns based on adjusted closing prices, 8/1/2013-10/31/2015 All funds outperformed more than half of the time against negative return months for the S&P 500 ETF. It is noteworthy that USMV had a higher return with lower standard deviation over the period (see Criteria 1) than VOO despite only outperforming in roughly a third of positive months and 70% of negative months. In contrast, both SPLV and LGLV had better up and down performance but lower returns than VOO. Clearly, this metric doesn’t tell the whole story, but is helpful in assessing tendencies of relative performance as the broader market goes through positive and negative periods. Criteria 3: Performance in periods where the S&P 500 faced a significant drawdown Since the time period in question is relatively short, there aren’t any decreases in VOO that are particularly steep. Regardless, we will examine the three largest drawdown periods since August 2013. This deeper look into the magnitude of out or underperformance relative to the benchmark will focus on performance when it matters most for low volatility investors. Three months stick out since August 2013. The total losses in each month aren’t particularly deep, but the lowest points in each drawdown are significant. To pass, the ETF in question will need to both outperform and have a smaller maximum drawdown in at least two of the three months. Intraday high and low prices for the respective month will be considered in determining the maximum drawdown. VOO SPLV USMV LGLV SIZE ERW August 2013 Month Return -3.08% -5.04% -3.26% -4.71% -3.30% -3.03% Drawdown -4.65% -6.19% -4.43% -6.26% -4.35% -4.25% January 2014 Month Return -3.53% -2.57% -3.04% -1.61% -1.95% -1.88% Drawdown -4.34% -3.53% -3.83% -2.89% -2.81% -3.23% August 2015 Month Return -6.14% -5.01% -4.53% -6.18% -5.59% -4.56% Drawdown -13.25% -48.35% -38.18% -8.96% -9.59% -6.95% Result Fail Fail Fail Pass Pass Source: Yahoo! Finance, monthly returns based on adjusted closing prices, 8/1/2013-10/31/2015 The August 2015 numbers may have caused a double take. It is well known that the carnage of August 24, 2015 brought many ETFs down well below their NAVs. Although it didn’t take long for the massive discounts to correct themselves, this experience highlights a real concern for ETF investors. Anyone caught with a stop loss or market order sell would have been at risk for a nasty surprise. Interestingly enough, it was the two largest ETFs that were affected. Only SIZE and ERW managed to pass this test. The August 2013 drawdown was particularly challenging for the group, while the opposite is true for the one in January 2014. Besides the deviation between price and NAV for SPLV and USMV, the August 2015 drawdown provides positive evidence of the effectiveness of low volatility strategies. I would be inclined to give more value to this drawdown, as it was significantly larger than the other two. Criteria 4: Fees Nothing eats away at returns quite like fees. The table below takes a look at several factors that will affect how expensive these funds are to hold and trade. VOO SPLV USMV LGLV SIZE ERW MER 0.05% 0.25% 0.15% 0.12% 0.15% 0.65% Average Volume 2,000,000 1,500,000 1,200,000 3,632 12,475 1,064 Spread 0.02% 0.03% 0.05% 0.49% 0.21% 1.19% Premium/Discount -0.09% -0.07% -0.07% 0.33% -0.31% -0.82% Result Pass Pass Pass Pass Fail Source: Morningstar.com on November 27, 2015 Fortunately, most of the ETFs are very reasonably priced, even against the super cheap VOO. Only ERW’s expense ratio is uncomfortably high. The spread and discount are also troublesome, although not entirely surprising given the small assets of the ETF. All in all, fees need only be a consideration for those interested in ERW. Although it would be nice to see SPLV come down to the 0.15% range, all four other ETFs are priced fairly. The spread and discount may seem a little high on some of the ETFs in the table, but keep in mind I was taking these down on a holiday shortened trading day, so they are likely understating the liquidity of a regular trading day. Conclusion Examining the four criteria gave valuable insight beyond the basic characteristics of the ETFs. SIZE was the only ETF to pass all four criteria. SPLV was the only to fail two, while the remaining three ETFs failed one each. Criteria SPLV USMV LGLV SIZE ERW 1. Risk-adjusted returns Fail Pass Pass Pass Pass 2. Up and down performance Pass Pass Pass Pass Pass 3. Drawdown performance Fail Fail Fail Pass Pass 4. Fees Pass Pass Pass Pass Fail Does this mean I think SIZE is the best of the bunch and should outperform the others in the future, at least in negative market environments? I would hesitate to go that far. For one, the available data only goes back a few years and doesn’t include many strong drawdown periods. However, based on the characteristics of the funds and the behaviour exhibited in our examined timeframe, I would feel comfortable using a low volatility product in a supporting capacity within the U.S. equity allocation of a portfolio. These products may be even more appropriate for somebody who is concentrated in a sector that is underrepresented in the funds, such as energy or technology. The only ETF I have reservations about is ERW. This small ETF trades thinly, with high bid ask spreads and a high expense ratio. It has done well in the performance criteria but this was influenced by the fact that we were looking at prices and not NAV. With ERW not trading some days and having low volume on the others, sizable discounts and premiums are common. I have nothing against the methodology of the underlying benchmark, but unless liquidity improves, it would be hard to place it above any of the other options. My recommendation is to consider combining any of SPLV, USMV, LGLV, or SIZE within your U.S. equity allocation. Of those four, there is no clear winner at this point. I will leave it to the reader to choose among them, and they are certainly differentiated in sector allocation, holdings similarity, and correlation. I deem all four suitable for lowering volatility and protecting on the downside as part of a larger U.S. allocation in a portfolio. Disclaimer: This article was not intended to be taken as investment advice. Please conduct due diligence of any ETF investment you are considering, including but not limited to a review of the prospectus, underlying benchmark methodology (if applicable), portfolio characteristics, holdings, performance since inception, role in your existing portfolio, and outlook for future performance.