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Low-Volatility ETFs at the Popular Table

Although asset flows into these funds have been robust this year, be mindful of expenses and don't chase performance, warns Morningstar's Alina Lamy.

Alina Lamy: Low-volatility ETFs have seen increased flows lately, and it's a trend that’s caught our attention. Currently there are 18 low-volatility ETFs in Morningstar's database, with $23 billion in assets as of May 13. The largest funds in this category are iShares MSCI USA Minimum Volatility and PowerShares S&P 500 Low Volatility. 

These ETFs aim to provide similar returns to the U.S. stock market, while at the same time taking on less risk. Obviously, that's an appealing concept for investors, especially after the January sell-off. Investors are still seeking exposure to U.S. equities, but are less willing to put up with the market's erratic ups and downs. 

Looking at monthly organic growth rates (that's flows over beginning assets), we can see that low-volatility ETFs grew at a peak rate of 17% in February, and have continued to grow at a robust pace since. In contrast, the organic growth rate for the SPDR S&P 500 was a negative 1% in February and remained close to zero for the next two months. Flows tend to follow performance, and low-volatility ETFs significantly outperformed the SPDR S&P 500, both year-to-date and over the trailing 12 months. 

However, as with any rapidly accelerating trend, the growing popularity of these low-volatility ETFs carries some concerns. These ETFs are more expensive--their average expense ratio is 29 basis points, as opposed to only 9 for SPY--and there are concerns that low-volatility ETFs may now be overvalued after such large inflows and may not be able to maintain such high returns in the future. 

As with all investments, investors should carefully consider the potential downsides, as well as the benefits, before buying into low-volatility ETFs.

Alina Lamy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.