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Invest in Low Volatility While Stocks Enter Bear Country

Investor fear of higher inflation, rising interest rates, and a possible recession have whipsawed markets and pushed the S&P 500 into a bear market for the first time since early in the pandemic.

The S&P 500 was down about 1.6% in intraday trading after just barely avoiding bear country. The Dow Jones Industrial Average, meanwhile, declined 1.3%, while the Nasdaq Composite lost 2.3%.

The S&P 500 and Nasdaq are on track for their seventh consecutive weekly loss, the longest losing streak these indexes have faced since 2001. The Dow, meanwhile, is on course for its eighth straight weekly decline, its longest such streak since 1932. All three indexes were recently on course to finish the week down at least 4%, according to.

In response to the Federal Reserve’s aim of slowing the economy enough to contain inflation but not so much that it leads to a recession, Arun Sai, a multi-asset strategist at Pictet Asset Management, told the Wall Street Journal: “We still need to build more evidence to convince markets that a soft landing is possible.”

But as stocks have been falling across the board in 2022, low-volatility indexes have generally held up better than their counterparts. While the MSCI USA Minimum Volatility Index is down 9.7% for the year to date through May 17, the Morningstar US Market Index posted a loss of 15% loss for the same period.

“Low-volatility strategies look best when markets are at their worst,” writes Benjamin Slupecki at Morningstar, adding that “the minimum-volatility index outperformed during the bursting of the dot-com bubble, the global financial crisis, and the coronavirus pandemic.”

The Invesco S&P MidCap Low Volatility ETF (NYSEArca: XMLV), which tracks the S&P MidCap 400 Low Volatility Index, outperformed its Morningstar Index by 4.47 percentage points. This puts the ETF in the 13th percentile this year when compared with its peers in its category.

ETF investors seeking to capture the upside of small cap equities without the added volatility can do so with the Invesco S&P SmallCap Low Volatility ETF (XSLV). XSLV, which seeks to track the investment results of the S&P SmallCap 600 Low Volatility Index, is in the small-blend category and outperformed its Morningstar Index by 2.54 percentage points.

“The lack of sector constraints allows [XSLV] to make outsize bets that may overwhelm its risk-reducing properties and hurt its performance,” writes Morningstar associate manager research analyst Lan Anh Tran.

But while low volatility ETFs are designed to be less volatile than their selection universes, Ben Johnson, director of global exchange-traded fund research for Morningstar, warned that “Low volatility does not mean no volatility, just less.”

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