How to choose a volatility ETF

Text size

Investors are investing more and more in an exchange-traded fund that seems to promise protection at a time when equities, and the economy in general, seem to be the most vulnerable for years. The problem: the fund is perhaps one of the riskiest investments on the market today.

the
iShares Edge MSCI Min Flight U.S.A.
The ETF (symbol: USMV) has attracted nearly $ 9.5 billion this year, the second largest and much better known
Vanguard S & P 500
(VOO). The iShares ETF has grown 42% in the last eight months to $ 32 billion. It is now the largest low-volatility ETF, more than twice the size of its next competitor, the $ 12 billion.
Invesco S & P 500 low volatility
(SPLV), which also attracted assets.

Interest of investors understandable: as volatility increases, investors seek security. And the returns of the iShares ETF have been remarkable: up 22% in 2019, compared to 18% for
S & P 500.
A number of studies have also suggested that low-volatility funds may offer better returns and lower risk than traditional index funds; The most famous is a study conducted in 2014 by a New York University economist and hedge fund strategist AQR, titled "Betting Against Beta" (Betting Against Beta), the Wall Street term indicating how much an action is closer to the rest of the market.

The argument for the outperformance of low volatility stocks is essentially a value argument. As the stock market rises, new investors tend to be attracted by rising stocks. Index funds, which are primarily market capitalization weighted, also hold a larger portion of the best-performing stocks as they rise. On this basis, low volatility stocks are often relatively undervalued.

This is not the case now. The average share of the iShares ETF is 24 times the earnings of the last 12 months, compared to 19 for the S & P 500; all ETFs trade at a premium of 17% over their MSCI benchmark. A recent Leuthold Group study found that low volatility stocks, compared to their higher volatility counterparts, are 99% more expensive than they have been over time, dating back to 1990.

Another problem is the interest rates. Low volatility stocks tend to be in sectors that are doing better when interest rates fall. The unexpected fall in interest rates this year, for example, probably explains why low-flying ETFs have been so successful in 2019. Interest rates may not increase any time soon, due to lack of strength. of the economy, but they will probably not fall. much more, either. This could temper a little enthusiasm for low volatility strategies for a moment.

Finally, the ETF itself is diversified from one sector to another, rather than holding the least volatile stocks,
Invesco

ETF does, the iShares ETF holds the least-flying stocks in each sector. This leads to greater diversification – the Invesco ETF tends to be heavily weighted in utilities and real estate – but may result in unexpected volatility. For example, the iShares USMV fell by more than 10% during last year's market turmoil from mid-August to the end of the year; the S & P index rose nearly 10% over the same period. Even in this case, "we believe that a diversified low-volume approach over time will produce returns similar to those of the market with lower risk," says Holly Framsted, head of US Factor ETFs for BlackRock.

However, research affiliates found that the more adjusted a simple portfolio with low volatility, the less effective it was to mitigate market downturns. Feifei Li, a partner and head of investment strategy at Research Affiliates, prefers the Invesco ETF for this reason. Its portfolio has a slightly lower average price / earnings ratio (23) than that of iShares (24). The fund is unlikely to outperform the market (it faces the same rate difficulties as the iShares ETF), but it will probably do a better job. to protect your money, which is why you bought a low volume ETF.

E-mail: [email protected]