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Steady Funds for Rough Markets

When bull markets arrive, however, investors favor high-volatility stocks in sectors such as technology and industrials. Those companies often report earnings surges in better economic times. In comparison, utilities and staples businesses seem like stodgy performers with slow growth.

Following the financial crisis, low-volatility stocks recorded unusually strong performance. Nervous investors flocked to utilities and other dividend-paying blue chips. That pushed price-earnings ratios up to unusually high levels.

In recent months, low-volatility stocks suffered particularly poor relative performance as investors gained confidence and shifted away from expensive dividend stocks. Rising interest rates encouraged the move from utilities and dividend stocks.

For income-oriented investors, dividend stocks seem less appealing as bonds offer more competitive yields. If the economic recovery stays on track and interest rates keep rising, the low-volatility funds could continue to lag.

The low-volatility ETFs use a variety of approaches to select their stocks. PowerShares S&P 500 Low Volatility picks the 100 stocks in the S&P benchmark that recorded the lowest volatility in the past 12 months, as indicated by a measure known as standard deviation. Current holdings include such stable blue chips as cereal giant Kellogg (K) and power producer Consolidated Edison (ED).

While such blue chips can hold their value in downturns, the fund presents risks because it is highly concentrated. The portfolio has 29.8% of assets in utilities and nothing in technology.

SPDR Russell 1000 Low Volatility spreads its bets a bit more. The SPDR portfolio has 14.9% of assets in utilities and 3.9% in technology. If interest rates spike, the SPDR fund would likely fare better than its PowerShares competitor would.

At the time of publication, the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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