|The Low Volatility Factor
Contrary to what would be expected under the classical Capital Asset Pricing Model, numerous academic studies have demonstrated that low-volatility or low-risk investing outperforms the broad market as well as high-risk strategies over a long-term investment horizon, and with much less realized volatility.
In the U.S., the S&P 500 Low Volatility Index returned 9.4% (10.6% standard deviation) on an annualized basis over the 10 years ended March 31, 2015, with 23% to 30% lower volatility than a market cap-weighted benchmark such as the S&P 500, which returned 8.0% (14,8% standard deviation).
|Low Volatility ETFs Gain in Popularity
Low volatility exchange-traded funds (ETF) make an excellent option for conservative investors that want to participate in the upside of the market with less downside risk.
These tools can be used as core holdings within the context of a risk-averse portfolio or as tactical positions to minimize draw down during periods of heightened volatility.
They thus provide an allocation to stocks with a historical penchant for lower price fluctuations than their peers. In the US, low volatility ETFs have gathered over $17 billion in assets.
|Strong Seasonal Effect Favours Low Volatility
Seasonal effects have been evident in global stock markets for decades (Halloween Effect, “Sell in May and go away”, Santa Claus effect), as recorded in numerous academic studies.
In Europe, the seasonal effect is particularly strong, with the strongest months for stocks generally the October-April period.
Interestingly, over the last 15 years the European Low Volatility index has outperformed the STOXX Europe index from February through to September, suggesting that favouring a low volatility strategy for these 8 months of the year should yield a much better Sharpe Ratio.
|The scale of outperformance
In Europe, since 2000 the S&P Europe Low Volatility index has gained 255% to end-March 2015, a compound annual growth rate of 8.7%.
In contrast, the benchmark STOXX Europe index has only managed a cumulative 56% gain over the same period, or a CAGR of just 3.0% .
In particular, the maximum drawdown of the Europe Low Volatility index was just 17% during the 2000-03 bear market compared with a 49% drawdown for the STOXX Europe, and a 47% drawdown in the 2007-09 financial crisis compared with a 54% drawdown for the STOXX Europe.
|A Variety of Low Volatility Methodologies
The S&P Low Volatility methodology is based on an unconstrained selection of the 100 lowest volatile stocks issued from the S&P 500 index. The MSCI approach differs from this one, since the index includes correlation and sectorial constraints.
Historic performance reveals a substantial difference between the S&P Low Volatility and MSCI minimum volatility methodologies: From the end of 1999 to end-March 2015, the S&P 500 Low Volatility index (total return) gained cumulative 323%, i.e. 9.9% CAGR, while the MSCI USA Minimum Volatility index gained only 167%, i.e. 6.7% CAGR.
|SPDR EURO STOXX Low Volatility ETF (ZPRL)
The SPDR EURO STOXX Low Volatility ETF , as a stock vehicle, is correlated with Euro Zone equities, but it displays a lower risk profile.
Indeed, the strategy aims to track the EURO STOXX Low Risk Weighted 100, which is focused on the lower volatile EURO STOXX Index’s components. The underlying methodology is based on a 12 months historical volatility weighted approach. So, the higher the volatility, the lower the stock’s weight. Further, each component is capped at a maximum weight of 10% on a quarterly basis.
At the end of March, the strategy is up +17,53% YTD and the dividend yield is close to 2,45%.
|Sources: Opportunité SA, BlackRock iShares, Morningstar, SPDR StateStreet and STOXX|
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