Morningstar - Q3 2021 - 63

Dot-Com Bubble Burst
0.7
0.8
0.6
05/28/1993
EXHIBIT 2
time frame, the more likely it is we'll see this
relationship hold. Indeed, from November
2011 (the first full month after USMV's inception)
through May 2021, USMV and SPLV had
respective downside-capture ratios of 62.8%
and 60.8% versus the Morningstar US
Market Index.
These funds' recent performance underscores
three key points that investors must keep
in mind when assessing the merits of these funds
and deciding where they might fit within their
portfolios: (1) You're trading upside participation
for downside protection; (2) results may vary
from fund to fund; (3) low volatility does not mean
no volatility-just less.
Not All the Same
There are important, albeit nuanced, differences
in the way low-volatility strategies are
constructed. The disparity in USMV's and SPLV's
recent performances is a testament to that.
EXHIBIT 2 provides further evidence. It shows the
absolute value of the spread in the monthly
performance of the best- and worst-performing
funds among the 10 U.S. large-cap low-volatility
ETFs that existed as of the end of May over
the trailing five-year period.
In the case of USMV and SPLV, these differences
point back to the funds' overarching approach
to portfolio construction. USMV attempts
to build the least-volatile portfolio of stocks it can,
choosing from the MSCI USA Index. SPLV's
portfolio is made up of the 100 least-volatile stocks
from the S&P 500. There's a distinction
between combining stocks to form the leastvolatile
portfolio versus building a portfolio of the
least-volatile stocks. At first blush, it may
seem trite, but the complexion of these funds'
portfolios is markedly different.
A look at sector exposures illustrates the
differences in their approaches. USMV's sector
exposures are relatively stable. That's
because its index tethers its sector weights to
those of its parent index. They can't stray
more than 5% in either direction from this
reference point. SPLV has no such restrictions
in place, which can lead to large and persistent
sector bets.
06/2018
01/2019
08/2019
Source: Morningstar Direct. Data from June 2018 through May 2021.
03/2020
10/2020
05/2021
05/28/1999
05/28/2005
05/28/2011
05/31/2021
Results May Vary The disparity of returns of low-volatility strategies is a reminder
that there are differences in how they're constructed.
Monthly Performance Differential Between the Best- and Worst-Performing
U.S. Large Cap Low/Minimum-Volatility/Beta Funds.
8%
6
4
2
At the height of the market in mid-February
2020, utilities and real estate stocks
made up nearly 47% of SPLV's portfolio. At that
time, stocks from those same two sectors
represented just 17% of USMV's portfolio. SPLV's
exposures in these sectors explained just
over half of its relative underperformance versus
USMV from the mid-February peak to the
late-March trough.
Methodological differences between these
seemingly similar funds are important
to understand, as they can lead to material
differences in their long-term risk/reward profiles.
Less Volatility
Low volatility does not mean no volatility,
just less. Low-volatility stock funds are still
stock funds. They are designed to be less
volatile than their selection universes, and there's
no question that they have delivered based
on that criterion. But it can be dangerous
to equate " less " volatility with " low " volatility.
The former is a more apt description and
one that would better calibrate investors'
expectations. The latter better describes assets
that would better diversify equity risk, like
high-quality bonds.
The most promising feature of these funds is
that they could-in theory-help investors
stay in the market during trying times, dulling the
pain they experience each time they check the
value of their portfolio. But we're deeply skeptical
that they can serve that function, and the
massive outflows from these funds since the
March 2020 market bottom is evidence
in the case against their palliative potential.
We don't think most investors take comfort in
losing relatively less when the market hits
an air pocket. And they certainly don't like being
left in the dust when it rebounds sharply
off the bottom.
Investors need to understand that while these
funds may have a place in their risk-management
tool kit, they are specialized implements.
Less-volatile equity portfolios rank well below
setting aside a rainy-day fund, having an
appropriate asset allocation, and going for a walk
outside the next time you're tempted to tinker
with your portfolio. K
Ben Johnson, CFA, is director of global ETF research for
Morningstar Research Services LLC. He is a member of the
editorial board of Morningstar magazine.
morningstar.com/lp/magazine
63
https://www.morningstar.com/authors/680/ben-johnson http://www.morningstar.com/lp/magazine

Morningstar - Q3 2021

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Contents
Morningstar - Q3 2021 - Cover1
Morningstar - Q3 2021 - Cover2
Morningstar - Q3 2021 - 1
Morningstar - Q3 2021 - 2
Morningstar - Q3 2021 - Contents
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