A Sound ETF Idea For 2016

It took Tuesday's strong showing to lift the S&P 500 into positive territory for 2015, but for now, the benchmark U.S. equity index is sporting a year-to-date gain of less than one percent. That does not mean equity investors have not been rewarded this year.

Select strategies offered by exchange traded funds have easily outpaced S&P 500 index funds this year with low volatility ETFs shining particularly bright. Count the iShares MSCI USA Minimum Volatility ETF USMV among the low volatility funds that trumped traditional S&P 500 offerings this year. The $7.1 billion USMV is up nearly five percent in 2015. 

Low volatility stocks could be winners again in 2016 due to divergent global monetary policies. That is exactly what investors are dealing with as the Federal Reserve ebbs closer to its first interest rate hike in nine years, while the Bank of Japan, the European Central Bank and others engage in easy monetary policies.

“It’s no surprise that volatility is expected to be a semi-permanent fixture in the markets for the forseeable future,” according to a recent BlackRock note. “Emotions tend to drive many investment decisions and this often causes investors to buy high and sell low, which is the very opposite that we need to be doing. Sadly, this often results in lackluster performance.” 

USMV, which celebrated its fourth anniversary in October, minimizes volatility by following the MSCI USA Minimum Volatility (USD) Index. Emphasizing volatility reduction does not mean USMV places a premium on boredom. If one views consumer staples, telecom and utilities as “boring” sectors, then USMV could seen as a pleasant surprise because those groups combine for just over a quarter of the ETF's weight.

USMV's top 10 holdings include four members of the Dow Jones Industrial Average and of those four, three are found among the 18 Dow stocks that are up this year – Johnson & Johnson JNJ, McDonald's Corp. MCD and Verizon Communications Inc. VZ. None of USMV's 170 holdings command a weight north of 1.6 percent.

USMV does bring some excitement, sort of, to the world of low volatility investing by way of 36 percent allocation to healthcare and technology stocks, sectors that are often underweight in rival low volatility ETFs. Since the financial crisis, volatility in financial services stocks has ebbed, helping the sector attain prominence in low volatility ETFs. USMV is no exception as financial services names are the ETF's largest sector weight at 21.5 percent.

And yes, data confirm USMV makes good on the reduced volatility promise. The ETF's beta is just 0.68 with a standard deviation of about 9.3 percent, according to issuer data.