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Low Volatility Works With Ex-U.S. Developed Markets, Too

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Low Volatility Works With Ex-U.S. Developed Markets, Too

The low volatility phenomenon is enthralling investors this year, and inflows to U.S.-focused low volatility exchange-traded funds confirm as much. However, the low volatility factor's utility is not confined to U.S. borders.

Nearly half of the world's combined equity market capitalization is found outside the United States, but U.S. investors often associate international investments, even developed markets fare, as being more volatile than domestic equivalents. Combine the home country bias with perceptions about volatility and there is a logical explanation for why most U.S. investors heavily tilt their portfolios to U.S. investments.

International ETFs And Low Volatility

This year, investors are warming to the advantages of low volatility international ETFs, including the iShares Edge MSCI Min Vol EAFE ETF (NYSE: EFAV). As its name implies, EFAV is the low volatility alternative to the iShares MSCI EAFE Index Fund (ETF) (NYSE: EFA). Flows data confirm investors are clearly preferring the low volatility solution this year.

Related Link: How A Low Volatility ETF Works Is As Important As Why

EFA has not lost any assets this year, but has not added any either. Conversely, investors have poured nearly $2.5 billion of new money into EFAV. That data point shows investors are getting it right. EFAV is up 3.7 percent year-to-date, while EFA is down 0.1 percent. EFAV is also doing its job, as its year-to-date volatility has been 520 basis points below that of EFA.

It's More Than Just Low Volatility

EFAV “doesn't just target the least-volatile stocks. It takes into account each stock's exposure to common risk factors and the co-variances among them to better estimate how the holdings will contribute to the portfolio's overall volatility. This may be a suitable core holding for conservative stock investors,” according to Morningstar.

A combined 62.7 percent of EFAV's weight, in order, is allocated to Japan, the UK and Switzerland. By comparison, the traditional MSCI EAFE Index allocates half of its combined weight to those countries. EFAV's weight to Japan is more than 600 basis points above EFA's, contributing to a lower dividend yield on the former, but that also means EFAV investors have more exposure to Japanese dividend growth.

Looking Down The Road

As is the case with U.S.-focused low volatility strategies, data suggest that over the long haul, EFAV can be a winner.

“From its back-filled inception at the end of May 1988 through April 2016, the MSCI EAFE Minimum Volatility Index outpaced the MSCI EAFE Index, with 78 percent of the volatility. This is consistent with independent studies, which have shown that low-volatility stocks have tended to offer better risk-adjusted returns than the market. Part of this attractive performance profile is due to low-volatility strategies' tilt toward stocks with low valuations and high profitability, two characteristics that have historically been associated with better returns,” added Morningstar.

 

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