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Investors ducking for cover in the rocky market are turning to low volatility funds. The Franklin International Low Volatility High Dividend Index ETF (LVHI) has the added bonus of providing income. The fund is rated five stars by Morningstar, which cited a “strong long-term risk adjusted performance.” LVHI, with $4 billion in assets under management, has a 3.35% 30-day SEC yield and a 0.40% expense ratio. Low volatility funds, in general, look to smooth the ride for investors by holding stocks that have smaller price fluctuations. That can mean they may underperform when the market is riding high. That’s not the case this year. LVHI is up about 8% year to date, excluding dividends, as of midday Friday, while the S & P 500 is down nearly 7%. On Friday, all three major indexes tumbled, with the Dow Jones Industrial Average briefly falling as much as 10% from its recent high — technically, a correction . “This is a great strategy that people look towards when there’s a lot of turbulence,” said Jeff Silverman, head of advisory solutions at Franklin Templeton Investment Solutions. Some $469 million has flowed into the ETF just since Jan 1. International diversification These days diversification is also really important. LVHI gets that through international stocks, while hedging the currency exposure in an attempt to further reduce volatility. “These stocks may be driven by different economic forces than your traditional domestic stocks,” Silverman said. International stocks have “a low correlation to growth and it’s been more defensive than your traditional value strategies.” The ETF is rules based, which means it follows rules of an index when selecting investments, rather than tracking an index, which in LVHI’s case is the MSCI World ex U.S Index. Managers start with about 3,000 of the largest international developed stocks and then run screens. First, they look for high dividends and companies where earnings exceed payouts. Then, they screen low volatility by measuring price and earnings volatility. The managers end up with a pool of about 150 to 200 stocks from which to choose. “If you’re just looking for high dividends and you’re avoiding the volatility of the price and the earnings, you can be missing something, because high vol can be an indication that something is afoot that may not allow you to sustain those dividends,” Silverman said. The end result today is overweight positions in energy stocks, consumer staples and utilities. “These do quite well in times of turbulence. That’s where money flows — to more defensives,” he said. “Even in times where the economy is softening, that overweight in utilities would do quite well.” Domestic option There is also a domestically-based option, the Franklin U.S. Low Volatility High Dividend Index ETF (LVHD). Its investment universe is confined to the Russell 3000 Index. The domestic ETF has a 30-day SEC yield of 3.26% and a 0.27% expense ratio. It is also outperforming the broader market, up 6.6% year to date. Top holdings include Verizon Communications , Chevron and American Electric Power . Roll cage Both funds should be considered a conservative core holding within a portfolio, regardless of market volatility, Silverman said. The ETFs can balance out the more “higher octane exposures,” like tech, and act as a risk mitigation solution, he said. He likens it to driving a race car, which have stronger seat belts and roll cages for added protection. “You need to have something in that portfolio that’s also going to be a bit of a ballast, a bit of a safety — a roll cage in that portfolio,” Silverman said. “As investors, we cannot control … returns,” he added. “Returns are random, based upon economic regimes and the shifting of those regimes, but what we can control is the volatility of a portfolio.”
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