Canadian investors might feel like they’re on an endless roller coaster ride, with headlines often screaming crisis one moment and opportunity the next. This year, the financial news cycle has been dominated by concerns over increasing interest rates and tumbling bank stocks, contributing to a sense of unease about what’s coming next.
Take a moment to pause and put things into perspective. Bear markets, which are typically defined as periods when stock prices fall 20% or more from recent highs, are a natural part of the investing landscape. They reflect the uncertainties that come with the territory of seeking returns that outpace what you could earn from investments considered risk-free, like GICs.
However, if the thought of a bear market sends chills down your spine and you’re concerned you might react hastily to a traditional stock investment strategy, fear not. There’s an ETF that might just suit your needs during these turbulent times.
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Understanding volatility
It’s common to see the stock market as one large entity where everything moves together, but in reality, that’s far from true.
Stocks are like snowflakes — no two are exactly the same, especially when it comes to risk. Each stock has its own personality, some are steady and calm, while others are more like wild roller coaster rides.
In this varied landscape, one type of stock often stands out, particularly during bear markets: low-volatility stocks. These are the ones that tend to be less affected by market swings. To understand this better, let’s look at two key concepts: beta and standard deviation.
Beta is a measure of how much a stock’s price jumps around compared to the whole market. If a stock has a beta of 1, it tends to move just as much as the market. If it has a beta less than 1, it’s less jumpy than the market; more than 1, and it’s more of a thrill ride.
Standard deviation is another way to see how much a stock’s price fluctuates. Think of it as the average amount a stock’s price moves away from its average over time. If a stock price typically doesn’t stray far from its average, it has a low standard deviation. On the other hand, if the price is all over the place, the standard deviation is high.
For example, consider a stock like a large utility company. It might have a low beta, meaning when the overall market goes up or down, the stock doesn’t react too dramatically. It also might show a low standard deviation because the price of this utility stock doesn’t change wildly; it usually hums along close to its average.
In contrast, a tech start-up could have a high beta. When the market surges or plunges, the start-up’s stock might swing even more. Its standard deviation might also be high, indicating that its price can be quite unpredictable and vary a lot from its average.
An ETF for low volatility stocks
I like BMO Low Volatility Canadian Equity ETF (TSX: ZLB). This ETF uses a carefully crafted, rules-based method to pick Canadian stocks that historically have had a lower beta and standard deviation. This means that the stocks within ZLB tend not to swing as wildly as the market overall.
What’s particularly noteworthy about ZLB is its composition. It tends to be overweight in sectors that are known for their defensive nature – utilities and consumer staples. These industries typically sell products and services that are always in demand, recession or not, which contributes to the stability of the stocks within these sectors.
When it comes to cost, ZLB has an expense ratio of 0.39%. While there are cheaper options out there, this fee is generally considered reasonable, especially when you weigh it against the time and effort it would take an individual investor to replicate this kind of low-volatility strategy on their own.
