Low-Volatility Stocks Are Riskier Than You Might Think. Here’s a Better Way to Play Them. By Evie Liu Updated Oct. 11, 2019 7:28 am ET / Original Oct. 11, 2019 6:30 am ET Order Reprints Print Article Text size Matt Hardy Buying stocks with the lowest price volatility has become one of the most popular investing strategies this year, amid the mounting uncertainties surrounding theU.S.-China trade war,Brexit, and the slowing global economy. Since the beginning of the year, the iShares Edge MSCI Min Vol USA exchange-traded fund (ticker: USMV) has grown its assets under management by 80% to $35 billion, ranking as one of the top asset-gathering ETFs this year. The Invesco S&P 500 Low Volatility ETF (SPLV) has added $2.6 billion new assets to reach nearly $13 billion. Investors like low-volatility strategies for a good reason: They’re beating the market. While theS&P 500increased merely 1.9% over the past six months, the two ETFs have soared 8.5% and 7.8%, respectively. Still, as Goldman Sachs strategist Ben Snider points out, low volatility doesn’t mean risk-free. “Investors who focus on price stability while ignoring fundamental growth stability may find that they have embraced riskier stocks than they intended,” he wrote in a research report last week. In many cases, low price volatility comes hand in hand with stable fundamental growth, but that might be simply driven by a transient macroeconomic environment or other short-term drivers, and when that changes, volatility can spike quickly. For example, a company might enjoy low volatility in share prices following a period of strong dividend growt hdue to slow economic activity and low interest rates. But when economic growth improves and rates rise, it could suffer a sharp selloff. That’s why the turnover for low-volatility portfolios is much higher than other fundamental-driven strategies. The low-volatility basket has recently included a lot of momentum stocks, which are the market’s most-recent best performers but are known for high turnover. The sudden selloff of a few of these stocks could have a drag on the entire low-volatility group’s performance. According to Snider, the low-volatility stocks in the Russell 1000index have posted a median return of 24% year to date, more than 4 percentage points higher than the index’s median constituent. Yet those stocks with the most volatile historical earnings growth—despite their recent low price volatility—have returned just 14%, lagging the index median by 6 percentage points. “Selecting stocks based on share price volatility alone will capture some companies with stable underlying fundamentals, but will also capture companies whose recent price stability is more likely to be transient,” he wrote. “As a result, some min-vol stocks may be riskier than they appear.” Investors seeking more stability should consider volatility in both fundamental growth and share price movement, suggests Snider. Snider and his team looked at the volatility of S&P 500 companies’ quarterly year-over-year earnings growth during the previous 40 reported quarters. They found that since 1985, stocks with the most-stable earnings growth relative to their sector peers have price/earnings ratios that are an average 9% higher than the broader market, while stocks with the most-volatile earnings growth saw a discount of 4% in their average valuations. Even after controlling for profitability, expected growth, and sector performance,stability in fundamental growth still brings an extra layer of outperformance. It isn’t hard to understand why. Intuitively, investors would trust that stocks with historical growth stability are more likely to grow at a predictable rate in the future as well. That can be proved in Wall Street analysts’ earnings estimates, which tend to be clustered closer together for companies with stable growth. On the flip side, Snider listed 32 stocks that investors should be wary of when building a low-volatility portfolio—namely, those with low price volatility but volatile historical earnings growth and high uncertainty in analyst estimates for 2020 earnings. The list includes tech giantsApple (AAPL) and Texas Instruments (TXN), drugmakers Merck (MRK) and Pfizer (PFE), fast-food chains Wendy’s (WEN) and Chipotle Mexican Grill (CMG), and travel websites Expedia Group (EXPE) and Booking Holding (BKNG). Some low-volatility ETFs are already taking other factors that might introduce unwanted risks to the portfolio into account. The iShares Edge MSCI Min Vol USA ETF, for example, doesn’t look only at price volatility when picking stocks, but also mitigates sector bets and avoids outsize exposure to lower-quality companies to achieve a “balanced portfolio of low-correlated stocks” in order to lower portfolio risk, according to Holly Framsted, head of iShares U.S. Factor ETFs. The iShares Edge ETF has outperformed the S&P 500 over the past one, three, and five years by 10.0, 5.6, and 16.6 percentage points, respectively. Write toEvie Liu atevie.liu@barrons.com https://www.barrons.com/articles/debra-brede-stock-opportunities-abound-51570812173