2022 has been a tough time for investors, with major market benchmarks entering bear markets after prolonged declines. Many shareholders have seen the stocks they held lose 50% or more of their value this year alone, in some cases restoring massive gains from previous years.
Given the volatility of the stock market so far this year, investors have paid much more attention to defensive investments designed to hold up better than the broader market during tough times. In particular, low-volatility ETFs allow investors to stay invested in stocks, but with an eye toward reducing the violence of the ups and downs of their portfolios. Despite a mixed story, low-volatility ETFs got the job done in 2022, though that may not mean exactly what some of those who bought these wealth-protecting investments think.
What low volatility ETFs try to do
The idea behind low volatility ETFs is simple. Their goal is to allow investors to gain exposure to the stock market, but avoid the full brunt of bear market downturns.
Different ETFs take different approaches to achieve this goal. The Invesco S&P 500 Low Volatility (NYSEMKT: SPLV) The ETF only focuses on stocks that are part of the S&P500 index. Meanwhile, iShares Edge MSCI Minimum Volatility United States (NYSEMKT: USMV) has a slightly broader universe of stocks to choose from, incorporating both large and mid-cap companies in the US market.
These two ETFs hope to provide exposure to US equities with less risk. In particular, investors are hoping that in a bear market environment, these low-volatility ETFs will manage to preserve wealth more effectively than a simple index fund.
How Low Volatility ETFs Fared in 2022
Indeed, looking at their performance so far this year, low volatility ETFs have done what they were supposed to. As you can see below, the two ETFs mentioned above have suffered losses since the start of the year, but they are well below the corresponding losses in the S&P 500 as a whole.
The source of the outperformance of low-volatility ETFs was largely companies in traditionally defensive sectors of the market, such as healthcare and consumer staples. Among the top performers among the fund’s holdings are biotech giants Gilead Sciences and Amgenas well as consumer brand leaders Hershey and PepsiCo. Additionally, some other strong stocks performed well, including defensive contractor General dynamics and healthcare conglomerate Johnson & Johnson.
Accept smaller payouts
The problem with low volatility ETFs, however, is that they don’t tend to outperform the market when it rises. And because the market goes up more often than it goes down, it can lead to dramatic underperformance.
For example, look at what happens when you expand the performance time horizon to three years:
This period had of them bear markets, but it also included a long period of strong gains from mid-2020 to late 2021. As you can see, the S&P 500 took a huge lead during the bull market phase, and even now that ETFs at minimum volatility are faring much better, there is still a wide performance gap between the two.
Monitor your risk level
Ultimately, investors might be happier holding the stocks in which they have the greatest conviction, but temper their level of risk by making allocations to other types of assets, including fixed income and cash. This strategy can be just as effective in managing risk while providing the benefit of allowing you to invest in companies you truly believe in.
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Dan Caplinger has no position in the stocks mentioned. The Motley Fool fills positions and recommends Gilead Sciences. The Motley Fool recommends Amgen and Johnson & Johnson. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.