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Worried About Interest Rate Sensitivity? New Low Volatility ETF Screens For It

Worried About Interest Rate Sensitivity? New Low Volatility ETF Screens For It

ETF investors have become enamored with low volatility funds as a method of investing in a basket of high quality stocks with a lower overall beta to the market. The process in constructing these ETFs is relatively simple – take a broad index such as the S&P 500 and eliminate the stocks with historically minimal price fluctuations.

What remains is a diversified portfolio of publicly traded companies with a penchant to outperform the benchmark index on the downside, while still participating in the market's upside gains.

Relatively New Concept

PowerShares was one of the first to introduce this concept with the PowerShares S&P 500 Low Volatility Portfolio (PowerShares Exchange-Traded Fund Trust II) (NYSE: SPLV) that debuted in early 2011.

Since that time, the fund has amassed over $5.2 billion in assets and continues to be a sound solution for those looking to reduce the peaks and valleys of their equity portfolio. 

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Nevertheless, the smart index methodology used to construct SPLV tends to lean towards stocks with a high sensitivity to interest rates. These defensive sectors are typically concentrated in utility, telecommunication and consumer staples fields.

To address that issue and offer a complimentary solution, PowerShares has introduced a new fund with a two-factor approach.

PowerShares S&P 500 Ex-Rate Sensitive Low Volatility Portfolio

The PowerShares Exchange-Traded Fund Trust II (NYSE: XRLV) screens the top 400 stocks within the S&P 500 Index with the highest correlation to the 10-Year Treasury Note yield. It then reduces that list down to the 100 lowest volatility stocks with a positive correlation to interest rates.

Not surprisingly, XRLV has zero exposure to utility or telecom services sectors. It makes up for that with overweight position in financial, industrial and consumer discretionary groups.

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Unlike SPLV, which weights its constituents equally, XRLV will institute an inverse volatility weighting system. The stocks with the lowest volatility scores will receive the highest weightings within the ETF, and therefore have the greatest pull on the performance of the fund.

This new offering will be the first of its kind to offer low volatility with interest rate sensitivity built in and may be an attractive solution for those worried about the long-term trend of U.S. bond yields.

XRLV debuts Thursday and will charge an expense ratio of 0.25 percent.

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