In the last 14 months or so, Canada’s ETF providers have launched several funds based on low-volatility strategies. As we saw in my last post, the research suggests it may be possible to build a portfolio of stocks with lower volatility than the broad market without sacrificing expected returns. But exactly how do you select those stocks?
There are several ways to implement a low-volatility strategy, so before you consider any of the new ETFs, make sure you understand how they differ. Today we’ll take a look at the methodologies used by BMO and PowerShares. Next week we’ll look at the iShares strategy.
BMO looks at beta
Rather than tracking an index, the BMO Low Volatility Canadian Equity (ZLB) simply uses a transparent set of rules. You start with the 100 largest stocks in Canada and rank them according to their beta over the previous 12 months. You then select the 40 with the lowest beta: the lower the beta, the greater the company’s weight in the fund. No stock can make up more than 10%, sectors are capped at 35%, and the fund is rebalanced just once a year.
Beta can be a confusing concept.