Potent exposure to small stocks with low volatility

This ETF looks for a proper balance of valuation and profitability.

Alex Bryan 28 March, 2017 | 5:00PM

 PowerShares S&P SmallCap Low Volatility ETF (XSLV) aggressively pursues small-cap stocks with low volatility. It should offer a smoother ride and better risk/reward profile than the S&P SmallCap 600 and most of its peers. But it can make concentrated industry bets at times and may require high turnover. And it has a limited record. These considerations limit its Morningstar Analyst Rating to Bronze.

While small-cap stocks tend to be more volatile than their larger counterparts, the performance advantage from tilting toward low-volatility stocks has historically been the largest among the smallest stocks. A big part of this edge has come from avoiding the riskiest small-cap stocks, which tend to trade at high valuations and have poor profitability, two characteristics that have historically been associated with lackluster performance.

So far, the fund's approach has worked well. From its inception in February 2013 through January 2017, the fund exhibited about 13% less volatility and about 24% less market sensitivity than its parent index. It also beat the benchmark by 203 basis points annualized during that time, largely because of more-favorable stock exposure in the financial-services industry.

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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.