iShares Edge S&P 500 Min Vol ETF USD Acc (LSE:SPMV) - ETF price

ETF Report

iShares Edge S&P 500 Minimum Volatility UCITS ETF USD (Acc) SPMV



The S&P 500 Minimum Volatility Index attempts to create the least volatile portfolio of stocks selected from the S&P 500. To do so, it uses the Northfield Open Optimizer and the Northfield US Fundamental Equity risk model, subject to several constraints. These constraints keep the stock weightings between 0.05% and 2% of the portfolio, sector weightings within 5% of the S&P 500, and two-way turnover limited to 20%. The algorithm also applies constraints to limit tilts to other factors, such as value. These constraints improve diversification, but they may reduce its style purity. While pure low-volatility portfolios hold only low-volatility stocks, this minimum-volatility portfolio may comprise average- to high-volatility stocks because of the risk diversification benefits they bring to the overall portfolio and the constraints built into the optimiser. As such, overall, it is hard to identify precisely why one stock is in the portfolio versus another. The S&P 500 Minimum Volatility Index represents about 36% of the roster of constituents in its parent index. It consists of around 100 stocks, with the largest 10 holdings accounting for approximately 21% of the total weighting. The index is rebalanced semiannually, in March and September.

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The fund has an ongoing charge of 0.20%, making it one of the cheapest strategic-beta ETFs with exposure to the US Large-Cap Blend category. Also, in a marketplace where many S&P 500 ETFs charge less than 0.15%, this fund's ongoing charge is only slightly higher than its cap-weighted counterparts. The fund typically outperforms its benchmark. This is mainly due to the differences in withholding-tax treatment between this Irish-domiciled fund and the index. The double taxation treaty between Ireland and the U.S. allows the fund to enjoy a better withholding tax rate on US dividends than the S&P 500 Minimum Volatility Net Total Return Index. Securities-lending revenues may have also contributed to partially offset the fees.

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This fund uses full physical replication to capture the performance of the S&P 500 Minimum Volatility Net Return Index. The fund owns--to the extent that is possible and efficient--all the underlying constituents in the same proportion as its benchmark. It also uses futures to mitigate tracking error risk. IShares engages in securities lending to enhance the fund's performance, lending up to 100% of the securities in its fund. Parent company and lending agent BlackRock covers the operational cost involved in securities lending for a 37.5% stake in the revenue generated from this activity, while the fund keeps 62.5%. Securities lending exposes the fund to counterparty risk, or the possibility that the borrower will not return the securities it borrowed. To manage this risk, BlackRock takes collateral greater than the total loan value. Collateral levels vary between 102.5% and 112%. Acceptable collateral includes equities (up to 40%), government bonds, and in some cases cash. In the 12 months to the end of March 2019 the fund lent out 5.5% of its assets on average and generated a 0.01% return. BlackRock also provides indemnification for its iShares ETFs. If a borrower defaults and fails to return borrowed securities, BlackRock will replace them. The indemnification agreement is subject to changes without notice.

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iShares Edge S&P 500 Minimum Volatility offers investors a smoother ride in the US large-cap equity market. This sensible approach to reduce volatility of the overall portfolio combined with a low cost should allow the fund to beat its Morningstar Category peers in the long run. Hence, the fund earns a Morningstar Analyst Rating of Silver.

The fund's benchmark attempts to construct the least-volatile portfolio possible with stocks from the flagship S&P 500, under some constraints. These constraints limit turnover, exposure to individual names, and sector tilts relative to the S&P 500. All these improve diversification, but also reduce style purity--pure low-volatility portfolios only hold low-volatility stocks, whereas this minimum-volatility portfolio may include average- to high-volatility stocks to improve diversification and because of the constraints built into the optimiser.

There is a lot of historical evidence supporting a minimum-volatility approach. The strategy proved particularly effective during a volatile 2018. This has further improved the fund’s live track record, which began in November 2012, outperforming the average category peer and its parent market-cap index. However, we have yet to see how the strategy would fare during a major market meltdown. During the trailing five years for the period ended May 2019, the fund outpaced the US large-cap blend equity category average while displaying below-average risk.  

The strategy certainly reduces the volatility of returns. However, such defensive posture comes at a cost of lagging during strong bull markets. The fund has displayed a lower-than-average upside capture ratio most of its live market run, which has coincided with a strong upswing for US equities.

The ongoing charge of 0.20% makes this fund one of the cheapest in the category. In terms of tracking performance, the fully replicated iShares Edge S&P 500 Minimum Volatility ETF outperformed its benchmark because of favourable withholding-tax differences between the index and the fund.  

All in all, the strategy’s sound approach to constructing a defensive equity portfolio and its low cost support our positive view on the fund.

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Fundamental View

Historically, less risky stocks (as defined by volatility or market sensitivity--beta) have offered better risk-adjusted returns than their riskier counterparts. This effect was first documented in 1972 by Fischer Black, Michael Jensen, and Myron Scholes. They found that stocks with low sensitivity to market fluctuations (low betas) generated higher returns relative to their amount of market risk than stocks with high sensitivity to the market. Several other researchers found a similar pattern for stocks sorted on volatility.

Robert Novy-Marx, a professor at the University of Rochester, attributes low-volatility stocks' attractive performance from 1968 to 2013 to their low average valuations and high profitability in his paper, "Understanding Defensive Equity." He argues that investors would be better off targeting stocks with value and profitability characteristics directly because there is no guarantee that low-volatility stocks will always have these characteristics. In fact, this fund explicitly limits its value tilt.

While low valuations and high profitability likely contributed to low-volatility stocks' attractive historical performance, there is probably more to the story. Many investors care about benchmark-relative returns, which may cause them to favour riskier stocks that have higher expected returns in bull markets, reducing their expected returns relative to their risk. Similarly, neglected lower-risk stocks can become undervalued relative to their risk. This is not necessarily the same as the traditional value effect, as many of these stocks often trade at comparable or slightly higher valuations than the market. Andrea Frazzini and Lasse Pedersen, two principals from AQR, develop this argument in their paper, "Betting Against Beta."

A limitation to all volatility-related strategies is their reliance on backward-looking risk measures. One can question the use of historic volatility as an indicator for expected risk in the future, even if the strategy incorporates other factors like correlation. There is no guarantee that the least volatile stocks historically will remain so going forward. In fact, these stocks may become more volatile as more money flows into them and their valuations increase, as has been witnessed in recent years.

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Several providers offer a risk-reducing approach to US large-cap stocks, including Invesco, Lyxor, BNP Paribas, and Ossiam. Ongoing charges for these ETFs range between 0.17% and 0.65%, with Amundi IS MSCI USA Min Vol ETF levying the lowest fee of 0.17%.

Investors looking to pair low volatility and income may consider the Invesco S&P 500 High Dividend Low Volatility ETF (0.30% ongoing charge). This fund provides exposure to the 50 least-volatile and highest-yielding stocks in the S&P 500.

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AJ Bell Management Limited (company number 03948391), AJ Bell Securities Limited (company number 02723420) and AJ Bell Asset Management Limited (company number 09742568) are authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales at 4 Exchange Quay, Salford Quays, Manchester M5 3EE. See website for full details. AJ Bell procures the provision of the Morningstar Licensed Tools on an “as is” basis and does not guarantee the performance of or accept liability for the Licensed Tools. To the maximum extent permitted by law, AJ Bell excludes liability for the Licensed Tools, including liability for any failure, interruption, delay or defect in the performance of any Licensed Tool, unless it arises as a direct result of the negligence of AJ Bell.
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