How Good Are Managed-Risk ETFs?

The value proposition for the DeltaShares strategy is strongest for the small-cap segment.

Option market makers love volatility. Retirement-minded investors and their advisors? Not so much. Volatility’s a bugaboo mostly because of its association with market downdrafts. Historically, the correlation between the S&P 500 Index and the CBOE Volatility Index—also known as the “Fear Index”—has been strongly negative, meaning that when folks say the market is getting more “volatile,” it tends to mean it’s going down.

Volatility’s effect is corrosive. As most investors and advisors know from experience, falling off a market cliff is easier than regaining the lost ground. If, for example, the market is drawn down 10%, it takes a subsequent 11% gain just to get back to breakeven. The now-smaller asset base needs a bigger boost to restore itself to its former value. Lose 25% and the market must climb 33% to claw its way out of the hole.

In an effort to combat these depredations, a number of low-volatility portfolios have been floated in the exchange traded fund space. Some of these products have become wildly popular as market choppiness—a more benign word for fear—has increased. 

If there’s any trouble with these ETFs, it’s that the low-vol switch is forever in the “on” position. Volatility, though, ebbs and flows, as you can see in the trajectory of the CBOE Volatility Index depicted in Chart 1.


Research has long established the existence of a low-volatility anomaly contravening the direct relationship between risk and reward postulated by the Capital Asset Pricing Model. By keeping drawdowns in check, low-vol portfolios can and do outperform conventional index products. In the end, that is. At times, a low-vol tactic can actually act as a drag on performance during an investor’s holding period. The standard deviation of a low-vol ETF can be paradoxically higher than that of its conventional analog. That could produce disastrous results for investors who don’t time their investments well.

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Disclosure: None.

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