For example, ETFs with "low volatility" or "minimum volatility" in their names can turn out to behave quite differently for investors in precisely the environment that they are most looking for risk mitigation. Likewise, some sector-focused ETFs may offer similar exposures, even though their names are different — infrastructure versus construction, for instance.
A fund's name might seem like a good starting point for gaining an initial understanding of how it is constructed – "Infrastructure," for example, would seem to have something to do with the facilities, roads and power supplies needed to operate society. Unfortunately, names turn out to offer little help for evaluating funds. There is simply no universally accepted system in use by ETF providers and research to classify funds. S&P has its Global Industry Classification Standard, Morningstar has a Global Equity Classification Structure and these systems are as subtly different from each other as their own names.
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Since discrepancies will continue to exist in how ETFs are named and categorized, investors need to understand the underlying index methodology of the funds they are considering. Methodology signals how an ETF is likely to perform in different market conditions, and it also dictates how securities are selected and weighted, and the timing and frequency with which the portfolio is rebalanced.
Understanding the methodology of a fund's underlying index requires knowledge of whether it employs a constrained or unconstrained approach and how that might impact the performance of the portfolio.
An unconstrained approach to volatility, for example, utilizes a transparent, rankings-based methodology that evaluates each stock's realized volatility within a given universe over a specified period and selects stocks that have exhibited lower amounts of volatility.
The term "unconstrained" comes from the fact that the strategy is not constrained by sector or geography. While an unconstrained low-volatility index may have sector or industry overweights when volatility strikes, it can reallocate away from volatility during scheduled re-balancing.