AppId is over the quota
WHEN it came to stock market volatility, 2011 was pretty close to the mother of all roller-coaster rides. The Standard & Poor’s 500-stock index had several daily swings of 2 percent or more in August alone. The Dow Jones industrial average seesawed more than 400 points for four straight days that month. With the sturm und drang of European and American debt woes continuing, we may see more bipolar market oscillations. The investment climate — even among wealthy investors — has cooled toward stocks that have full exposure to the market’s ups and downs. A recent survey by the Spectrem Group found that “while somewhat more moderate in risk tolerance than in 2009, investors remain more interested in protecting principal than growing their assets.” So it comes as no surprise that Wall Street has hatched a new generation of products that cater to those who hate market volatility. Not only can you reduce your exposure to the most spasmodic stocks, you can also bet against wild price swings, although neither strategy is a flawless safeguard against market risk. This new generation of “low-volatility,” exchange-traded funds focuses on established companies with consistent earnings flow and dividends. You can now find a low-volatility fund for nearly every corner of the global stock market. The PowerShares S.& P. 500 low-volatility fund invests in 100 companies from the index that “exhibited the lowest sensitivity to market movement, or beta, over the past 12 months.” Skittish about emerging-market stocks? The iShares MSCI Emerging Markets Minimum Volatility Index Fund could be worth a look. Tilting more toward small companies in the United States? The Russell 2000 Low Volatility fund focuses on small- and micro-cap stocks with strong growth prospects. What if you want to bet squarely against the downward volatility of the S.& P. 500 index? Then you might consider the iPath S.& P. 500 Short-Term VIX fund, a complex exchange-traded fund based on futures contracts that track the implied volatility of the index. For an even broader approach, Lance Gunkel — a fee-only certified financial planner with Sherpa Investment Management in West Des Moines, Iowa — uses the SEI Managed Volatility Fund, which covers a low-volatility index representing 3,000 stocks that may also invest in futures and options. The fund’s load-adjusted return was nearly 10 percent compared with a nearly flat performance for the S.& P. 500 Index last year. The companies in the low-volatility funds he chooses for his clients tend to be “cash-flow rich with low price/earnings ratios, dividend paying with a value tilt,” Mr. Gunkel said. While there is an appeal to tamping down portfolio extremes, the low-volatility strategy is no substitute for a comprehensive reduction of market risk. While many low-volatility funds track stocks that have had fewer price swings on average over the last year, that may not be the most prudent way to avoid future volatility. If low-volatility funds were concentrated in “safer” stocks like dividend-rich utilities and major energy producers in 2011, unless they shifted gears to match market sentiment for this year’s favored sectors, they might fall victim to “sector rotation,” as professional money managers shift into other industries and sell the favored stocks of the previous year. Last year’s darlings may be this year’s goats. Also keep in mind that most of these funds have been started within the last few years. Few, if any, have been battle-tested in a 2008-style collapse, which is when you would need them to offer real protection. (And they are not to be confused with balanced funds that have a mix of bonds or cash, or more exotic “inverse” funds that move in the opposite direction of stocks.) Lee Munson, the author of “Rigged Money” and a financial planner and registered adviser with Portfolio, in Albuquerque, said he was “offended by the gentle marketing lie” of low-volatility funds because they did not address the larger need to reduce market risk in times of market crisis. Every low-volatility fund is still exposed to the market. And still looming is “event risk,” like the threat of a European country defaulting on its debt. A lot of investors, Mr. Munson maintained, mistakenly “confuse low volatility with low risk,” adding: “You can’t call a Lexus a Mercedes. People think that when the market goes down, I won’t get hurt in these funds. They’re all stocks.” Mr. Munson suggested a more enlightened view that looks at “risk budgeting,” or gauging how much risk you can take, and design a portfolio that tracks your tolerance — or intolerance — for stock market exposure. It is also possible to reallocate easily to include more bonds to offset equity holdings. Real diversification includes investments that do not move in lock step when the market turns south. A qualified investment adviser or certified financial planner can also help you hedge risk in other ways, like buying options on specific stocks or indexes you may own. The goal, as always, is to developthe portfolio that best provides for your needs in the least stressful way.
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