Look What's Lurking In This Low-Volatility ETF
Take a poll of investors who are familiar with low-volatility exchange-traded funds, of which data suggest there are plenty, and ask those investors what sectors they would use to build a new low-volatility ETF.
Chances are those polled would say a low-volatility ETF should include consumer staples and utilities stocks. Some healthcare names as well and maybe industrials. Obviously, not all low-volatility ETFs are mirror images of each other, but, along with financial services, some combination of the aforementioned sectors is often found in low-volatility ETFs.
Let's Look At USMV
Not surprisingly, higher beta sectors such as energy and materials usually garner only scant allocations in popular reduced volatility strategies. So it might surprise some investors to learn that Newmont Mining Corp (NYSE: NEM) is the largest holding in the popular iShares Edge MSCI Min Vol USA ETF (iShares Trust (NYSE: USMV)).
Alright, so Newmont is only 1.7 percent of USMV's weight. However, the stock is the second-largest holding in the Market Vectors Gold Miners ETF (NYSE: GDX). What makes this interesting is that GDX's three-year standard deviation of 43.7 percent is nearly five times the comparable metric found on USMV.
Clearly, some investors, including professionals, are not bothered by this. USMV's $4.87 billion of year-to-date inflows confirm as much. Only two ETFs have added more new money this year. This is where things get really interesting.
The Interesting Thing
“At some point if volatility picks up and shares are sold from this holding ETF then Newmont will also be sold proportionally,” said Rareview Macro founder Neil Azous in a note out Wednesday. “We are not that smart but implied volatility on Newmont is 49 and it's been realizing between 50 and 70 over the last 10-100 days.”
Azous rightfully questions whether or not a stock like Newmont should really be a low-volatility ETF's top holding, though to be fair, AT&T Inc. (NYSE: T) is not far behind Newmont on USMV's roster.
There is a scenario where USMV could become a thorn in GDX's side. Imagine market volatility rises, but investors finally return to the dollar as a safe-haven rather than gold. Gold and gold miners fall, leading to a spike in volatility for Newmont and other mining stocks, forcing USMV to sell or significantly trim its Newmont exposure.
With a 7.7 percent weight to Newmont, GDX would not like that.
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