The broad equity markets in the US saw heightened volatility this year amid continuing tensions around Greece, highly unpredictable oil prices and weak GDP data on the domestic front. Moreover, a fluctuating greenback and an unexpected slowdown in China – the world’s second largest economy, didn’t help investor sentiment either.
After the poor showing in the first quarter, economic readings failed to lift moods in the second quarter as well. Investors who thought the seasonal impact of Q1 was temporary may have to wait a little longer for sunnier days.
Recent data showed retail sales remained weak in April after witnessing the first quarterly decline in almost three years in Q1 this year. The sputtering wage growth and the sudden spike in energy prices expectedly sapped consumer confidence with the preliminary reading of the Michigan University/Reuters consumer sentiment index plunging to a seven-month low in May.
Though the high-frequency data sets have not been totally dismal, they surely have tempered expectations for an imminent interest rate hike by the US Federal Reserve. Indeed, the S&P 500 hit multiple lifetime highs since the beginning of 2015; but the rise was mostly punctuated by elevated volatility.
While investors can be reasonably sure of cheap money supply from the US banks going into the second half, they also need to reconcile with the Fed induced storm amid fluctuating economic data, at least for a couple of quarters more. Needless to say, many investors that wish to stay invested in domestic US equities find low volatility products extremely appealing.
To capitalize on investors’ interest, Invesco PowerShares Capital Management recently launched another so-called “smart-beta” product that reduces portfolio volatility while mitigating stock sensitivity toward interest rate hikes.
The freshly-minted PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (XRLV) is a tweak of the firm’s wildly successful $5.2 billion PowerShares S&P 500 Low Volatility Portfolio (SPLV) and takes the idea of weighting the S&P 500 Index alternatively a step further.
While SPLV successfully reduces the peaks and troughs of an equity portfolio, it is loaded with stocks that are highly sensitive to interest rate movements. Typically, stocks from utilities, telecommunications and consumer staples from the defensive sectors are overweight in SPLV’s basket.
Unlike SPLV, that selected the lowest volatility 100 stocks from the S&P 500 and weighted them inversely by their trailing 12-month volatility levels alone, XRLV selects stocks based on both volatility and immunity to interest rate increments.
However, individual components are weighted by volatility only while building the portfolio. No utility or telecom company finds a place in XRLV while exposure in consumer staples has been kept at a lowly 12.22 percent.
To counter the negative effects of rate sensitivity, XRLV allocates a healthy 33.18 percent to the financials sectors, followed by industrials (19.62 percent) and health care (13.94 percent).
Also, about 25 of its financial holdings are either regional banks or insurance & retirement solutions providers – the very sub sectors that tend to outperform in a rising interest rate environment. Industrials, materials and consumer staples are cyclical stocks that generally lead earnings when rates rise in a booming economy.
XRLV charges 0.25 percent annually.
Disclosure: No holdingsContact Ulli