Low-volatility exchange-traded funds are one of the ripest new fruits in stock indexing, feeding investors the most stable shares in popular equity benchmarks. But the low-volatility concept may be appreciated most when it is used on rockier shores, such as emerging markets or sovereign-debt-wracked Europe.

The iShares MSCI Emerging Markets Minimum Volatility Index fund (ticker: EEMV), launched in October, is enjoying the strongest recent returns in this niche, rising more than 12% this year through last Wednesday. Picking the most staid components of an index usually means lagging behind a rise in the broader index. But this recipe has worked well in a “risk-on” environment that has many investors on edge. The ETF is actually ahead of the 11% gain in the iShares MSCI Emerging Markets Index fund (EEM), from which its components are derived. For every 1% move in the emerging-markets index, the ETF rises or falls an average of 0.8%, by Morningstar analyst Samuel Lee’s estimate, so this outperformance may be fleeting. A competitor, the PowerShares S&P Emerging Markets Low Volatility Portfolio (EELV), is up 9.4% since its mid-January launch.

These funds have global counterparts like the iShares MSCI All Country World Minimum Volatility Index Fund (ACWV), ahead by 5.6% on the year, and other variants that screen out U.S. stocks, like the Russell Developed ex-U.S. Low Volatility ETF (XLVO), rising 4.5%. There’s a regional tracker, the Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT), that’s roughly flat since its January inception.

The industry is divided over just how complex or, “factor”-sensitive, low-volatility ETFs need to be. The most successful fund is the 11-month-old, $1.5 billion PowerShares S&P 500 Low Volatility Portfolio (SPLV), which may also be the simplest. It holds the 100 S&P 500 stocks that have experienced the smallest price swings in the last 12 months. The fund has risen 3.2% for the year through last Wednesday. Its roughly 30% weighting in utility stocks has been criticized, as has another 30% in consumer staples.

Axioma, the risk-modeling firm behind a competing product, argues its indexes’ more complicated screens are a better guard against unwanted exposures, such as too much concentration in a particular sector. Say this in their favor: Investors have gotten slightly more bang for their buck this year in the Axioma-powered Russell 1000 Low Volatility ETF (LVOL), up 5%, or in the iShares MSCI USA Minimum Volatility Index fund (USMV), another mathematically sophisticated rival, which is ahead by 6.3%.

The chief allure of low-volatility stocks is the “buy ‘em and forget ‘em” compatibility of the holdings. Over long stretches, the least-volatile stocks have done about as well as the broader market, but with less risk, notes Morningstar’s Lee.

Scott Kubie, chief strategist at CLS Investments and a fan of low-volatility ETFs, takes helpings of the relatively simple funds as well as the more complex ones. He uses the popular PowerShares low-volatility fund and the competing iShares U.S. minimum-volatility ETF on behalf of clients, since both allow him to get more equity exposure for each dose of risk.

For overseas plays, he uses the iShares minimum-volatility ACWI fund. “These funds are a good substitute for a 70% equity and 30% bond portfolio. It’s the same basic risk profile,” he says. 

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QUARTERLY MONITOR | By KAREN DAMATO

Bright Start to 2012

Stock investing felt downright easy in the first three months of this year, as the market staged a strong and mostly steady climb.

The result was an average total return of 12.3% for diversified U.S.-stock funds, according to Thomson Reuters Corp.’s Lipper unit. That was slightly behind the 12.6% return on the Standard & Poor’s 500-stock index, including dividends. The stock funds had lost an average of 2.9% in calendar 2011.

Shares in the technology and financial-services sectors were particularly strong, with sector funds focused on those areas returning 17.8% and 17.6%, respectively. Those areas also helped large-cap growth funds to an average 16.3% gain.

International-stock funds weren’t far behind the U.S., with an average 11.8% advance in the first quarter. That recouped part of the negative 13.4% average return in 2011.

Meanwhile, with interest rates so low, returns from bond funds were much smaller. The most popular category—funds holding intermediate-term, investment-grade bonds—returned an average of 1.5%, according to Lipper.

Among the 25 largest funds and exchange-traded funds, the best performer in the first quarter was the tech-heavy PowerShares QQQ Trust,

up 21.2%, according to Lipper. Bringing up the rear: Vanguard Total Bond Market II Index,

with a 0.1% return.

Still Avoiding Stocks

The first-quarter rally certainly didn’t make investors giddy about buying U.S.-stock funds. These funds continued to see more investor cash flow out than in, though the pace of net outflows slowed significantly from the second half of 2011.

So far in 2012, through March 28, U.S.-stock funds saw about $14.9 billion in net redemptions, according to the most recent estimate by the Investment Company Institute trade group. Foreign-stock funds took in about $5 billion.

Meanwhile, investors continued to show a strong preference for bond funds, with an estimated $93.7 billion going into taxable and tax-exempt bond funds, according to the ICI.

Quarter Ahead

• The April 17 tax filing deadline is also the deadline to make contributions to individual retirement accounts for 2011. Individuals receiving large tax refunds may want to consider reducing the tax withheld from their paychecks and instead directing those dollars into a 401(k) or other retirement plan.

• Over the next few months the Securities and Exchange Commission may propose new rules for money-market mutual funds, including capital requirements and/or moving away from the usually steady $1 share price. Many in the industry voiced opposition when the SEC floated these ideas earlier this year, and some of the SEC commissioners aren’t on board with Chairman Mary Schapiro’s call for action.

• ETF enthusiasts will be keeping an eye on how much cash goes into the Pimco Total Return ETF

launched March 1 as a close cousin of the giant Pimco Total Return

mutual fund. Recently, the ETF had $288 million in assets, compared with $252 billion in the mutual fund.

From the Manager’s Mouth

Hussman Funds

John P. Hussman

“Recent quarters have been largely characterized by a fragile underlying global economy coupled with a persistently overvalued stock market,” leading to a decision to hedge away almost all of stock risk. “We will certainly have periods where we appear remarkably out-of-step with the prevailing trend of the market, particularly in overvalued, overbought, overbullish periods of speculation.”

John P. Hussman


Hussman Strategic Growth

(First-quarter return: down 6.7%)

“When our analysts communicate in writing, in the absence of being able to raise our voices and pound the table to convey our convictions, we WRITE IN ALL CAPS. As we enter 2012, we want to express to you our belief that WE OWN SUPERIOR BUILDING BLOCKS THAT SHOULD GENERATE OUTSTANDING FUTURE INVESTMENT RETURNS.”

O. Mason Hawkins
, G. Staley Cates

Longleaf Partners

(First-quarter return: up 12.9%)

Ms. Damato is a news editor for The Wall Street Journal, based in South Brunswick, N.J. Email her at karen.damato@wsj.com.

Write to Karen Damato at karen.damato@wsj.com

A version of this article appeared April 5, 2012, on page C12 in some U.S. editions of The Wall Street Journal, with the headline: A Periodic Look at Performance And Where Investor Money Is Flowing.

By KAREN BLUMENTHAL

What does being “underwater” in your house really mean? Probably not that you’re drowning.

The number of underwater homeowners — those who owe more on their mortgages than their home is now worth — has been growing sharply since 2006 as real-estate prices have tumbled. By some estimates, between one in six and one in eight homeowners are in that position, most of them people who bought homes in the past few years or who put down small or no down payments.

This worries economists and policy makers, since owing more than your home is worth is the first step toward foreclosure. And it’s a concern to the rest of us because foreclosures are roiling the financial markets and, closer to home, they drag down our neighborhoods. (Most people who still have equity, by contrast, would rather sell their houses at a loss than lose what’s left of their investment.)

In response to concerns about rising foreclosure and delinquency rates, federal regulators are studying possible new programs aimed at needy homeowners. There are concerns that such programs could attract a flood of applications from those who don’t truly need assistance or encourage lenders to push homeowners into foreclosure. At the same time, lenders such as J.P. Morgan Chase

and Bank of America

have committed to working on new loan terms for the most-distressed homeowners.

But experts who have studied previous sharp housing downturns in Texas, California, New York and Massachusetts say that being underwater, while unpleasant, doesn’t lead huge numbers of homeowners to default on their mortgages and end up in foreclosure.

Christopher L. Foote, Kristopher Gerardi and Paul S. Willen of the Boston Federal Reserve Bank studied more than 100,000 homeowners who were underwater in Massachusetts in 1991 and found that just 6.4% of them lost their homes to foreclosure over the next three years, according to a paper published in the September Journal of Urban Economics. The vast majority of homeowners simply continued paying as usual because they focused on the affordability of their payments, not on what they owed, and they believed home values would eventually recover.

The economists found that homeowners typically lost their homes only after at least two things happened: Their home values dropped and they either couldn’t afford the payments or stopped making payments after losing hope that prices would eventually recover.

Homeowners in California also were more likely than expected to keep paying during the deep 1990s slump, says Richard Green, director of the Lusk Center for Real Estate at the University of Southern California. More people turned in their keys in Ohio and Michigan during the difficult 1980s downturn because they lost faith in an economic turnaround.

Typically, homeowners fall behind after a job loss, divorce or serious illness. In the current downturn, foreclosures are higher than in previous cycles because more homeowners reached beyond their means to buy their homes and simply can’t keep up the payments. As a result, the Boston economists project that up to 8% of underwater Massachusetts homeowners could lose their homes between now and 2010 — a significant amount, but still not catastrophic.

So what does this all mean for you?

If you have a low-interest fixed-rate loan, you have a valuable asset that might be hard to replace in the current market, no matter what your home’s value is. Keeping that mortgage current has some value, even if it means cutting other household expenses.

In addition, the penalties for defaulting are great. In most cases, walking away from a mortgage can knock a top credit score down to the cellar, says Ethan Dornhelm, a senior scientist at Fair Isaac Corp., which sells credit-scoring formulas to credit bureaus.

A person with a stellar credit score from the high 700s to the top score of 850 would see it drop more than 200 points. A person whose credit score is lower may see it fall by fewer points, but still end up with a score in the mid 500s. At that level, reasonably priced new debt, from credit cards to car loans, will be out of reach. In addition, a default could lead landlords and utilities to require more cash up front and even affect your job prospects.

If the borrower continues to pay other debts on time, the score will climb gradually, though it may take three to five years to return to “good” scores, from the mid-600s and up. Scores of 790 or more — which are rewarded with the lowest interest rates — won’t be attainable for at least seven years, when the default blemish finally disappears, Mr. Dornhelm says.

Fannie Mae

requires borrowers who have lost their homes to foreclosure to wait five years before it will accept a loan from them, though borrowers who had extenuating circumstances, such as an illness or job loss, may requalify within three years.

What’s more, lenders in most states can go after homeowners for an unpaid balance on a mortgage. That’s a real risk, especially if you have other assets.

The longer you stay in your house, the better the chances of making it through this down cycle. Though a return to peak prices may take five or 10 years, some housing markets may start to bounce back once credit becomes more available. Meanwhile, you’ll be reducing your mortgage as you make your payments.

Lenders aren’t going to renegotiate just because prices have fallen, but if you truly can’t afford your payments, contact your mortgage servicer to see if you can rework your interest rate or work out new payment options. The federal Hope for Homeowners program, which began Oct. 1, is intended to provide some relief if lenders will agree to reduce the loan amount to 90% of the home’s current value.

If you can’t get help from your lender, try contacting a credit counselor certified by the Department of Housing and Urban Development. These counselors have direct access to lenders’ loss-mitigation departments, which consumers don’t, says Natalie Lohrenz, counseling administrator for Consumer Credit Counseling Service of Orange County, Calif. A list of HUD-certified counselors is available through Hope Now, a consortium of lenders and counselors. (Call 888-995-HOPE or go to www.hopenow.com.)

If you need to sell the property and can’t afford to cover the shortfall, your lender may agree to a “short sale,” in which you sell at a price below the mortgage amount. This is a much more complicated transaction to pull off than a regular home sale, though, and it may hurt your credit score if the lender reports that you failed to pay off the whole obligation.

• Email: familymoney@wsj.com

Printed in The Wall Street Journal, page D1

On the third anniversary of the Mumbai attacks on Nov. 26, Indian home minister Palaniappan Chidambaram in an interview with the Times of India:

Whatever [India does] will never be “enough.” We are making up for past neglect. Huge capacity has to be built in strengthening security forces, in their training, in their equipment, in their deployment, in employing technology, in improving their mobility and striking power. Considerable capacity has been built in the last three years but still there is some distance to go. And even as we build additional capacity, the level of threat may also go up as adversaries are also building up their capacity. All that a government can do is to constantly ramp up capacity and remain at a high level of alert. We remain at a high level of alert, but sometimes it is possible that they slip through our defences as they did in Pune, Mumbai and Delhi, which I described as regrettable ‘blots’ on [our] record….

The United States has named [Jamaat-ud-Dawa, or JuD] as a terrorist organization and asked Pakistan to name it as a terrorist organization. I think it is completely unacceptable for Pakistan to say they have no evidence against [JuD chief] Hafiz Saeed. Hafiz Saeed must be investigated. He must be interrogated. But, if you treat him as a state guest for a while [place him under house arrest] and then let him go and do whatever he does and say whatever he says, it only brings into the question the credibility of the Pakistan government.

By KELLY K. SPORS

For small businesses looking for advice, the Internet provides an ideal consultant: the consumer.

All sorts of start-ups and small companies are using the Internet to involve customers in decisions on everything from what to sell, how products look and work, how much they cost, and even how the company operates, like what hours a store should be open or how its floor space should be laid out.

For business owners who are short on cash and have little margin for error, there are two big advantages to using consumers as advisers: They’re cheaper than the professional consultants that bigger companies routinely employ. And the end result is likely to appeal to customers because they were involved in creating it, says Ken Zolot, a senior fellow at the Ewing Marion Kauffman Foundation, a Kansas City, Mo., nonprofit that promotes entrepreneurship.

“Your customers might be better at designing your product than your elite team of product designers, who might be hiding in an ivory tower somewhere,” says Mr. Zolot. Consumers often will provide input out of sheer passion or in return for the chance to win cash prizes or other incentives, he adds.

Tapping Passions

Some companies survey consumers informally, just throwing out questions or ideas to followers on Twitter. Others use blogs or set up online communities where they ask customers to brainstorm or rate ideas.

Local Motors Inc. of Wareham, Mass., a small-scale auto maker started last year, lets anyone upload design ideas onto its Web site. The site occasionally hosts competitions for cash prizes of up to $10,000 in which registered members—who include trained design engineers and transportation experts—vote on the designs they like best or other decisions related to building the autos and how the company operates. The winning ideas are then incorporated in the cars the company builds. Members remain involved after the competitions, offering criticism and suggestions throughout the cars’ development.

Others have gotten consumers even more involved. Linda Welch, a Washington, D.C., serial entrepreneur, decided in mid-2007 to seek input from potential customers for a vegetarian and vegan restaurant she was planning. She set up an online forum that invited members to help decide what the restaurant would be called, what its logo would look like, when it would be open, what would be on the menu, and what the place would look like, “down to the size and shape of the tables,” she says. Members voted on various aspects of the restaurant, and Ms. Welch hosted monthly meetings where forum members could have face-to-face discussions.

“I was blown away by how smoothly it all went, because they were all so passionate about seeing this restaurant become reality,” says Ms. Welch. “Everybody sort of came in with their own expertise or interest.”

The project is on hold until she can raise the $800,000 or so in start-up cash she needs.

Several companies have sprung up to help businesses interact with customers. UserVoice Inc., based in San Francisco, sets up forums on clients’ Web sites where customers can contribute and vote on ideas. More than half of UserVoice’s 16,500 members are start-ups, says co-founder Marcus Nelson. One computer-storage-device start-up, for instance, recently used UserVoice. Hundreds of people voted on ideas to make the product work with wireless networks, among other things.

Striking a Balance

This approach can have drawbacks, entrepreneurship experts say. There’s the risk that the crowd that provides input isn’t representative of the people who might buy the product later on. And innovation may suffer.

Erik Noyes, an entrepreneurship professor at Babson College in Wellesley, Mass., who studies the effects of social networking, says studies have shown that too much democratization of innovation tends to discourage groundbreaking ideas in favor of middle-of-the-road approaches. “There’s a lot of research to show that the reason that people don’t innovate is because they follow their customer group to the bottom of the ocean.”

Entrepreneurs need to know when to follow their own vision and intuition and when to rely on crowd feedback, Mr. Noyes says. John Rogers Jr., who started Local Motors, has tried to strike that balance. He says companies that solicit public input have to respect it and make it clear how that input is being used, so that people feel appreciated. That involves resisting “that incessant pull to just make the decision in-house,” he says.

But he also has been diligent about building a community of people who can make valuable contributions to Local Motors’ car designs, by marketing his site on other sites that attract design enthusiasts and experts. He also relies on the 10-employee company’s design experts and paid consultants to implement customers’ ideas in practical, cost-effective ways, and he still sometimes makes executive decisions, like building the company’s first car for consumers in the Southwest because of the market potential there.

Companies also need to consider that outside contributors might seek compensation if their ideas are adopted. Local Motors, for instance, requires members of its online community to sign off on a lengthy legal agreement to avoid such conflicts.

–Ms. Spors is a writer in Minneapolis. She can be reached at reports@wsj.com.

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