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Minimum Volatility Portfolios of USMV and SPLV Reduce Risk

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Minimum volatility

The primary benchmark for any smart beta fund is to beat the return of the traditional market Index S&P 500 (SPY). Both the iShares MSCI USA Minimum Volatility ETF (USMV) and the PowerShares S&P 500 Low Volatility Portfolio (SPLV) select stocks on the basis of volatility. They choose those stocks that have low volatility scores. Volatility is a statistical measurement of the magnitude of asset price fluctuations over time. A comparison of NAV performance is shown in the below graph.

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Volatility score

USMV’s top holdings include AT&T (T), McDonald’s (MCD), and AutoZone (AZO). SPLV’s significant investments include Plum Creek Timber (PCL), Marsh & McLennan (MMC), and Verizon Communications (VZ). The top holdings of both funds are chosen on the basis of their volatility score. The volatility score is highest for the stock with lowest price volatility among its peers.

Conclusion

Smart beta funds are considered riskier than other funds because they modify the traditional index. In the worse case scenario, this can mean that your portfolio is underperforming even when the market is booming. However, there is another side to this coin. Sometimes an index can be modified in such a way that it experiences reduced overall portfolio risk, thereby making it less risky than the market itself. USMV and SPLV are two such smart beta funds that include only stocks with low volatility.

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