Getting Defensive Ahead of Inauguration Day With This Low Volatility ETF

On January 20th, Donald Trump will be sworn in as the 45th president of the United States. While he’s had perhaps the most unconventional path to the White House in recent memory, investors have to like what they’ve seen so far. Trump’s platform of deregulation and infrastructure improvements has won broad approval of the equity markets. The S&P 500 has jumped nearly 7% since Election Day with banks and steel producers especially benefiting.

Bullish investor sentiment has jumped dramatically since the election. If you’re a contrarian, that could be a signal that it’s time to consider taking some chips off the table. The market was considered expensive heading into the election and, following the “Trump Bump”, it’s even moreso now. With the number of unknowns still in play, it’s worth at least considering taking a more defensive stance in the near term and locking in some gains.

The PowerShares S&P 500 High Dividend Low Volatility ETF (SPHD) combines a conservative equity portfolio with an above average dividend. The fund starts by ranking all 500 components of the S&P 500 in descending order according to their trailing 12 month dividend yield. The 75 highest yielding stocks are selected with a limit of no more than 10 stocks from any one GICS sector. The realized volatility of those 75 components are then measured according to the standard deviation of daily price returns over the past 252 trading days. The 50 securities with the lowest realized volatility make the portfolio.

Since the fund’s inception in late 2012, the methodology has delivered. The High Dividend Low Volatility ETF has delivered an average annual return of 15.7% versus 12.9% for the S&P 500. The fund is also benchmarked to an index developed by S&P Dow Jones Indices. That’s important because S&P Dow Jones backtests results for its indices giving us the ability to see how the index would have performed prior to its inception. The backtested results show that the Low Volatility High Dividend Index would have returned an average of 11.5% over the past 10 years compared to just a 7% return for the S&P 500, an indication that this strategy performs well over the long term.

While the methodology tends to focus more on high dividends than low volatility, the risk metrics show a fund that’s about 20% less volatile than the S&P 500. The beta of the fund measures somewhere between 0.7 and 0.8 depending on the time frame used. Long term backtested portfolio statistics show about a 10% reduction in risk looking at the historical standard deviation of returns.

Dividend growth investors will no doubt find this fund and its nearly 4% yield appealing. I’ve made the argument before that, generally speaking, the dividend stock universe (and, by extension, dividend ETFs) are getting a little overcooked given the demand for such stocks in the low interest rate environment. While that’s the case for many dividend ETFs, that’s not so much the case for this ETF. High dividend yields often come as a result of low stock prices so it’s not surprising that this fund has a strong value tilt. The High Dividend Low Volatility ETF has a forward P/E of just 15 with heavier weightings to traditionally conservative areas such as utilities, industrials and consumer goods and services. These areas are overvalued compared to historical norms, again, due to the demand for high dividend stocks. The semiannual rebalancing, however, keeps this fund continuously on the undervalued end of the spectrum since many of the stocks that have run up get jettisoned as their dividend yields get pushed down.

Equity investors have had quite a run over the past couple months but it’s important to keep in mind that uncertain economic policies, the impact of Brexit and questions surrounding foreign relations still have the ability to impact the markets. Adding a defensive positioning to your equity portfolio while boosting your dividend yield may be an appropriate means of navigating the murky waters in the coming months.

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