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Summary I’m taking a look at SPLV as a candidate for inclusion in my ETF portfolio. I’m not huge on the expense ratio, but I like the other aspects of the ETF. The ETF is incredibly well-diversified which favorably impacts the standard deviation of returns. In the context of Modern Portfolio, the correlation and standard deviation of returns are very important. The ETF looks favorable in those regards. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio, and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. What does SPLV do? SPLV attempts to track the total return of the S&P 500® Low Volatility Index. At least 90% of funds are invested in companies that are part of the index. SPLV falls under the category of “Large Value.” Does SPLV provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is about 86%. This is pretty great for making the ETF fit under modern portfolio theory. The low correlation means it should be possible to use the ETF without raising the standard deviation of returns unless the risk ETF has a very high standard of deviation of returns. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation is phenomenal. For SPLV it is .5978%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, so the combination of reasonable correlation and lower standard deviation than SPY is giving this ETF a real chance at being selected for my portfolio. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and SPLV, the standard deviation of daily returns across the entire portfolio is 0.6410%. If we drop the position to 20% the standard deviation goes to .6899%. Once we drop it down to a 5% position the standard deviation is .7195%. I haven’t decided what exposure level I would use yet, but probably 5% to 10%. I really like the combination of low volatility and moderate to low correlation. If it wasn’t for the higher expense ratio, I’d consider making this a core holding. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 2.21%. The yield seems strong enough that it could be included in a retirees portfolio to bring some diversification benefits and a moderate dividend yield. I’m not a CPA or CFP, so I’m not assessing any tax impacts. If I were using SPLV, I would want it to be in a tax exempt account to remove any headaches associated with frequent rebalancing. Expense Ratio The ETF is posting .25% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. In my opinion, a .25% expense ratio is higher than I want to pay for equity investments. It’s still low relative to many other methods of investing, but I’m looking for long term holdings and I don’t want to give my investments away. I haven’t decided if it’s worth paying the higher expense ratio to include SPLV. If the expense ratio was under .10%, this ETF would have a very strong case for being included. Market to NAV The ETF is at a .05% premium to NAV currently. In my opinion, that’s not worth worrying about. It is practically trading right on top of NAV. However, premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. Largest Holdings The portfolio is extremely well diversified. The largest position is around 1.25% of the portfolio. That is solid diversification. The intense diversification is part of the reason the volatility of the ETF is so low. Check out the chart below: (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade SPLV with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. SPLV is a difficult ETF to make a decision on. For equity investments, the expense ratio is a bit high, but the relatively low correlation and standard deviation of returns make a pretty good argument for using at least a small position such as 5% in a long term portfolio. I could go either way on this one. I won’t consider it as a core holding (20%+) because of the higher expense ratio. Disclaimer: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock. Scalper1 News
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