The U.S. stock market is back at all-time highs again. Small-caps, for the first time in a while, are leading the charge. Tech stocks are still about 5% below their 2021 highs, but they've been clawing back.
For most investors, it feels like the good times are back. But not for all.
Those invested in low volatility ETFs haven't enjoyed the same success. The last time this group outperformed the market was back in 2018 during the Fed policy pivot and Q4 mini bear. Before that, you'd have to go back all the way to 2014-2015.
Consider the performance of the Invesco S&P 500 Low Volatility ETF (SPLV).
Since 2019 and especially over the past year, low volatility has been among the market's worst performing themes. With investors solely zeroing in on large-caps, tech and growth stocks, stodgy old dividend payers haven't been of much interest.
In fact, there's been a mass investor exodus from low volatility ETFs over the past year.
The ETF marketplace, in general, is one pace for another record year of inflows, but the low volatility has seen money withdrawn across the board. The 10 biggest money losers have shed more than a combined $20 billion in assets. Only the iShares MSCI USA Small-Cap Min Vol Factor ETF (SMMV) has seen any notable inflow over the past year and it's only around $200 million (most likely due to the small-cap factor, not low volatility).
But times may be changing.
One of the reasons why low volatility ETFs have tended to underperform in recent years is their overweights to value, defensive and cyclical stocks. Investors were largely (outside of the 2020 COVID bear market) getting double digit returns with low to modest risk. If you can get big returns in tech stocks without a huge amount of volatility, where is the appeal in low volatility stocks?
Value stocks have been underperforming for more than a decade. The Energy Select Sector SPDR ETF (XLE) has generated precisely a 0% total return over the past decade even after the 2021 rally. Banks have struggled in the prolonged ultra-low interest rate environment.
But value and cyclical stocks tend to shine in economic recovery environments. That's what the markets have been anticipating over the past few months as these three groups have transformed from laggards into leaders. If the post-COVID rebound can continue throughout the rest of 2021, low volatility ETFs may be poised to shine again.
Feast or Famine
One of the ETFs in this space that I like is the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD). This is a fund that starts with the 75 highest-yielding names from the S&P 500 and then targets the 50 least volatile stocks from that subgroup to invest in. It dividend yield weights the selected components, so it tends to also carry a much above average yield.
When conditions are right, there are few ETFs that are better. When its style is out of favor, though, it can be the worst of the worst.
Take a look at SPHD's year-by-year returns over the past decade.
With the exception of 2018, SPHD has essentially been either a 10% performer or a bottom 10% performer every year since it launched. If ever there was a fund that you should invest in during the right conditions, this one might be it.
But conditions indeed appear to be improving. Value, cyclical and dividend-paying stocks have all done well this year, although broader low volatility ETFs are still lagging behind.
This chart is a bit of a curiosity, since SPLV is still trailing the S&P 500 by more than 5% year-to-date, but SPHD is leading it by more than 7%. This can be explained by investors "the riskier, the better" attitude throughout 2021. Small-caps, micro-caps, junk bonds and leveraged loans have all done well and the high yield tilt of SPHD has ridden that wave to outsized gains. High yield was among the worst-performing dividend strategies in 2020, but it's been an entirely different story in 2021.
At a sector level, SPHD doesn't have the type of allocation that you'd expect would be delivering market-beating returns. Utilities and consumer staples have underperformed, while tech has been a mixed bag. Its cyclical allocation isn't abnormally large - just over 20% of assets - but its overweight to the highest-yielding stocks within those sectors has been the differentiator.
SPHD has a current yield of 4.3%.
SPHD has been a feast or famine proposition over its entire life. The past two years have been miserable for shareholders, but I believe that's about to change.
The global recovery appears to be intact. The fund's strong value tilt is positioned perfectly to take advantage of the recovery. Cyclicals are doing well again and dividend payers are slowing coming back into favor.
SPHD is already a top 20% performer within its peer group in 2021. Its positioning suggests it can soon become an elite performer yet again.