Which ETFs can protect in market volatility?

Laird, Adam_700x450

Volatile markets are always a challenge. “Don’t sell in haste” is an easy message when markets are calm, but sadly plans do not always survive contact with a market correction. The Investment Association reports more than £1bn was pulled from funds in January, and the promise of lowering volatility might be enough to tempt investors back into this market. I have looked at ETF options for investors craving safety in their portfolio.

Minimising volatility

Minimum volatility equity ETFs are one of the winners of the recent market crash. Broadly speaking, these strategies combine equities to build a portfolio with lower overall risk than the market.

There is a chance investors can benefit from the “low volatility premium”: less risky shares historically have higher Sharpe ratios than “lottery ticket” companies.

One example, the MSCI World Minimum Volatility index held its value during the worst of the market downturns, but still joined in the recovery in late February and early March. This was a similar story in other regions. As such, the iShares S&P 500 Minimum Volatility Ucits ETF is number two for inflows across all London listed ETFs so far this year.

As low volatility investing becomes more widespread, the theme is being incorporated into other strategies. I am watching the PowerShares S&P 500 High Dividend Low Volatility Ucits ETF. Launched in the UK last year and hugely popular in the US, it currently yields over 3.5 per cent.

My biggest fear is these ETFs will be perceived as low-risk. These are still equity portfolios and – in general – will fall in a downward trending market. For investors to break this trend, look again at bonds.

Bond ETFs have seen strong inflows this year; seeming more appealing as inflation and interest rates stay low. The premium for bearing credit risk on riskier corporate bonds has also been rising. However for a cautious portfolio, both SPDR and iShares offer high quality short duration ETFs.

“Gold has shown its ability to delight, gaining 20 per cent since the start of the year”


I would be remiss if I did not mention gold. Its performance has been spectacular so far in 2016. Gold is perceived as a “safe haven” asset, particularly appealing for those who believe a market crash might prophesy an overall government collapse.

Gold bugs have suffered over the past five years, as the price has capitulated by a third. But the metal has shown its ability to delight – gaining 20 per cent in the first few months of the year. For the past 10 years, gold has provided some protection for investors – it has generally performed better in months when the MSCI World is falling.

But there are risks with gold. First, do not mistake chemical stability for financial safety. Gold has shown in the past few years that heavy losses are not impossible. This will particularly be the case if the US hikes interest rates again. When cash can earn a decent risk-free yield, gold starts to look less shiny and more like a rock.

Another factor is exchange rates. It has been observed that the USD gold price tends to rise when the dollar weakens. However, at the same time, dollar weakness erodes returns for UK investors. This should benefit UK investors when gold prices are rising, but could magnify the loss when the dollar strengthens and gold falls.

Exchange traded commodities are probably the simplest way for investors to incorporate gold in an investment portfolio. Fees can be low – just 0.25 per cent annual fees for the iShares Physical Gold ETC. Hedged gold ETCs like db Physical Gold GBP Hedged ETC protect against adverse movements in the exchange rate.


Adam Laird is head of passive investment at Hargreaves Lansdown