Since the start of April, stock markets have been rocked by the volatility resulting from president Donald Trump’s ‘Liberation Day’ tariffs announcement.
While markets have now recovered their poise, the VIX index, which measures market volatility, remains more elevated than it was before the tariff sell-off.
Volatility can be disquieting, even if it is a normal part of investing, and one option in investors’ toolkits is to look at ETFs (exchange-traded funds) which aim to limit levels of volatility.
What is the VIX index?
The VIX or the CBOE’s (Chicago Board Options Exchange) volatility index measures market expectations of US stock price changes over the next 30 days.
The higher the VIX the higher the implied volatility in stock prices, and the lower the VIX the lower the volatility. For example, on 7 April, the index soared to 60.13 – its highest closing level since the pandemic after US stocks sold off on worries over the implications of the Trump administration’s trade policy.
HOW DO LOW VOLATILITY ETFS WORK?
These ETFs track indices which are constructed in such a way that they screen for stocks known for their historically low price volatility, so they won’t fluctuate as much as the broader market. The stocks are still from a diverse range of sectors and industries. There are UK-listed products which focus on global, US, European and emerging markets too.
Volatility is measured based on the standard deviation of daily returns over the past year. Stocks with less volatile price movements are favoured and included in the ETF.
Stocks in these indices are also weighted inversely to their volatility – so the less volatile stocks get a higher weight in the portfolio and if more volatile stocks are included in the ETF their weight is smaller. This allocation reduces the overall risk of the portfolio.
What are the characteristics of low volatility stocks?
Consistent dividend payments
Strong balance sheets
Reliable business models
Less sensitive to economic cycles, for example, consumer staples
As a point of comparison, the MSCI World Minimum Volatility index has just 269 constituents compared with 1,352 in the broader index. It has a more significant allocation towards healthcare, consumer staple and communications services stocks and a more limited weighting towards technology than its parent too.
Low volatility indices are rebalanced and reconstituted regularly to maintain their low volatility characteristics.
HOW HAVE LOW VOLATILITY ETFS PERFORMED?
There are several low volatility ETFs which performed well over one- and three-year periods, particularly those with a global focus.
The Xtrackers MSCI World Minimum Volatility UCITS ETF (XDEB) has returned nearly 10% to investors over the past year and 20% over three years. It has an ongoing charge of 0.25%.
As of 7 May, the top 10 holdings include Deutsche Telekom (DTE), T-Mobile US (TMUS:BCBA), Walmart (WMT:NYSE), Cisco (CSCO:NASDAQ) and Berkshire Hathaway (BRK:NYSE).
Another low-volatility ETF which has been performing well is the iShares Edge MSCI World Minimum Volatility UCITS ETF (MVOL) which has returned a broadly similar 9.9% over the past year and 19.9% over the past three years. The ongoing charge is 0.3%.
The MSCI World Minimum Volatility index at least seems to have passed its most recent test if we compare its performance to the MSCI World index over the recent period of market turbulence.
Over the past year the MSCI World Index has gained 12.6% (gross returns as of 30 April 2025) compared to the MSCI World Minimum Volatility index gaining 19.3% (again gross returns as of 30 April 2025).
Another recent addition to the roster of low volatility ETFs which has achieved a one-year return of 10.2% and which doesn’t track the MSCI World Minimum Volatility index is Invesco Global Active Defensive ESG Equity (LVLC).
The fund’s initial universe of approximately 3,000 global equities is screened using both exclusionary criteria and a ‘best in class’ approach, which selects stocks from each industry with the highest ESG scores.
Following application of this policy, the portfolio is constructed with a focus on low-volatility characteristics while meeting sector, industry and country constraints and maintaining lower carbon intensity relative to broad global equities.
This portfolio is then optimised based on factors around value, quality and momentum. This entire process is repeated monthly, and the fund’s holdings rebalanced accordingly. This fund has an ongoing charge of 0.25%.
LOW VOLATILITY ETF DRAWBACKS
Although low volatility ETFs can offer investors benefits within a diversified portfolio there are also some drawbacks. They may fall behind the broader market during strong bull markets because they favour stability over high growth.
They often have a higher concentration in certain sectors like utilities which could impact performance if that sector underperforms. Low-volatility stocks can sometimes trade at premium valuations, so as these stocks become more popular with risk averse investors, increased demand can drive up their price relative to their earnings.
Finally, these ETFs are not entirely risk-free although they aim to reduce volatility, and are subject to market risks meaning investors can still experience losses.
Mo’ath Almahasneh, associate manager research analyst at data firm Morningstar, says: ‘Despite the catchy name, low-volatility ETFs are still funds that invest in the equity market, which has historically been riskier than other asset classes, like bonds.
‘Investors choosing to invest in such strategies should still expect volatility, albeit less than their starting universes. These ETFs still have a role in an investor’s toolkit, but diversification across and within asset classes can also effectively dampen portfolio volatility.’
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
magazine
