Low-risk exposure to U.S. large-cap stocks

BMO Low Volatility U.S. Equity ETF should offer better downside protection than most of its peers.

Alex Bryan 31 October, 2017 | 5:00PM

 BMO Low Volatility U.S. Equity ETF (CAD) (ZLU) should provide lower-risk exposure to U.S. large-cap stocks than the S&P 500 and most of its peers, giving it a good chance to post strong risk-adjusted performance over the long term. The fund applies a sensible rules-based approach to target the 100 members of the S&P 500 with the lowest sensitivity to market fluctuations during the past five years, placing the greatest emphasis on the most-recent data.

Stocks that make the cut are weighted by the inverse of their market betas, pulling the portfolio toward the less-risky names. However, there is a 5% cap on individual stock weightings and a 25% cap on sector weightings. The managers rebalance the portfolio to these weightings twice a year. To mitigate unnecessary turnover, the managers allow stocks to stay in the portfolio as long as their market risk ranks in the lowest 120 of the selection universe. While this is a rules-based approach, the managers have discretion to deviate from them if they think a stock's past market sensitivity isn't representative of what they expect going forward.

BMO's focus on market risk is meant to capture risk that investors can't diversify and is not a measure of a stock's total risk. For example, a pharmaceutical company awaiting approval for a new drug may have high volatility that is not correlated with the broader market's performance, but low sensitivity to market fluctuations. This approach by BMO is reasonable since, in a diversified portfolio, the uncorrelated risk should wash out. It chose this approach because it believes that each stock's level of common risk is more likely to persist than its relative volatility.

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About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA, is director of passive strategies for North America at Morningstar. Before assuming his current role in 2016, he spent four years as an analyst covering equity strategies. He holds an MBA with high honors from the University of Chicago Booth School of Business.

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