Invest in Stocks With the Least Volatility

Tim Begany's picture

Tuesday, February 24, 2015 - 12:00pm

by Tim Begany

 

In recent weeks, bullish optimism and a resilient market have given investors a bit of a reprieve from rising levels of volatility. But don't get too comfortable. The next spike in volatility can arrive without notice. Here's how you can invest in stocks with the least volatility.

 

The CBOE Volatility Index, also known as the fear index, or VIX, has been trending lower for most of the year. The VIX, which gauges expectations for stock market volatility in the next 30 days, is now only around 16 -- 20% below the historical average of 20.

 

But 2015 is still young, and severe volatility could return as investors face potential shocks to the market. A shift in U.S. monetary policy or a potential Greek exit from the eurozone are just a few potential triggers for higher volatility.

 

Though volatility has been largely absent from the market in the past few years, recall that it was a key theme in 2011, when the market fell nearly 20% as part of a summer swoon. The VIX reflected investor angst during that period, spiking to as high as 48, or nearly 2.5 times the historical average.

                        

For ongoing protection from such events, investors would be wise to consider the iShares MSCI All Country World Minimum Volatility ETF (NYSE: ACWV).

 

I'm actually a fan of this $1.8-billion exchange-traded fund, or ETF, for two reasons: It cuts down significantly on volatility while providing broad, sensible exposure to U.S. and foreign stocks. And it does this without sacrificing anything in the way of returns.

 

The fund's strategy: track the MSCI All Country World Minimum Volatility Index, a benchmark composed of 350 of the world's safest stocks. Specifically, they're the 350 least volatile components of the regular MSCI All Country World Index (ACWI) of 2,400 domestic and foreign stocks.

 

As such, ACWV is tilted toward more defensive sectors like healthcare, consumer staples and utilities. It boasts many large household names with long histories of market leadership, profit growth and rising dividends.

ACWV Top 15 Holdings
Stock Industry Market Value (Billions) Portfolio Weight (%) Country
Automatic Data Processing (ADP)  Business Services  41 1.5 U.S.
Southern Co. (SO)   Regulated Utilities 42 1.3 U.S.
Johnson & Johnson (JNJ) Drug Manufacturing 279 1.3 U.S.
McDonald's Corp. (MCD)   Restaurants  92 1.3 U.S.
Takeda Pharmaceutical Co. (TKPYY) Drug Manufacturing 41 1.3 Japan
General Mills Inc. (GIS) Packaged Foods 32 1.3 U.S.
Nestle SA (NSRGY)  Packaged Foods 240 1.1 Switzerland
Novartis AG (NVS)   Drug Manufacturing 244 1.1 Switzerland
Verizon Communications Inc. (VZ) Telecommunications 203 1.1 U.S.
AmerisourceBergen Corp. (ABC) Medical Distribution 22 1.0 U.S.
Enbridge Inc. (ENB)  Oil & Gas Midstream 42 1.0 Canada
Colgate-Palmolive Co. (CL)    Consumer Products 64 1.0 U.S.
Procter & Gamble Co. (PG) Consumer Products 232 0.9 U.S.
Consolidated Edison Inc. (ED) Regulated Utilities 19 0.9 U.S.
Walmart Stores Inc (WMT) Discount Stores 276 0.9 U.S.
Source: Morningstar

 

 

Relatively safer, large-cap stocks like these make up 81% of ACWV, versus only a 19% allocation to smaller companies. Yet even many of the smaller stocks in the fund display well-below-average volatility because of their more defensive nature, such as Family Dollar Stores, Inc. (NYSE: FDO), PetSmart, Inc. (Nasdaq: PETM) and the American Water Works Company, Inc. (NYSE: AWK), to name a few.

 

As a result, this ETF has been 13% less volatile than the S&P 500 since its launch in October, 2011. It's 35% less volatile than the broader all-world index that it is based upon.

 

The fund's track record supports the notion that lower-volatility stocks outperform simply by being down less in rough markets. During the past three years, shares returned 13.1% annually, compared with a 6.6% rate of return for the 2,400-stock MSCI ACWI. The stocks in the fund currently provide a 2.2% yield, 30 basis points higher than the S&P 500. The expense ratio is a very cheap 20 basis points.

 

I see ACWV's overall asset allocation -- 59% North American stocks (mainly U.S.), 31% Asian stocks and 10% European stocks -- as optimal for today's global economy and a likely boon to performance. A primary focus on U.S. stocks makes sense, as our economy is still among the world's most transparent and reliable, with many years of solid growth ahead.

 

I also like the sizeable allocation to Asia, where economists project outsized long-term expansion. For example, China's GDP growth, while slowing, is still expected to be more than double that of the U.S. during the next five years.

 

Asian exposure also includes a 14% position in Japan, a potential boon because of that country's rising corporate profits, strong exports and the postponement of sales tax hikes. Plus, GDP growth in Japan is finally turning positive. Thus, some analysts project attractive long-term return potential for the Japanese stock market, which is already up nearly 7% year-to-date, compared with about a 2% gain for the S&P 500.  Xavier Denis

                                                                                                      

ACWV's allocation to Europe may seem too small in light of recent widespread bullishness about the region, a reaction to the announcement of a massive new central bank stimulus, similar to the Fed's stimulus program in the United States, which was completed last year. However, I think the 10% position is just right.

 

Shareholders won't be overexposed to Europe if the new stimulus fails; many analysts believe that a lack of plans for accompanying structural changes conducive to growth will still impede Europe's growth potential. But if the program works and European stocks respond (as U.S. equities did to Fed stimulus), then the current exposure is sufficient to give ACWV a performance boost.

 

Risks To Consider: U.S. stocks have been in a bull market for six years and are now expensive by many valuation measures. As the centerpiece of ACWV, they could hinder fund performance because their long-term return potential may now be somewhat modest, at least from current levels.

 

Action To Take --> Volatility is likely to be a key theme throughout 2015, and investors will certainly encounter it in the years ahead. Investing in the IShares MSCI All Country World Minimum Volatility ETF is an excellent way to reduce price fluctuation in your portfolio while gaining global stock exposure.

 

Because the fund is diversified and appropriately allocated, it's suitable as a core portfolio holding. Since the U.S. stocks that dominate the fund are so pricey, consider buying ACWV on larger dips or simply wait for the major correction so many investors strongly suspect is coming.

 

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Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.