Low volatility is a revered investment factor, but like anything else in investing, it’s not a free lunch. Traditional strategies associated with this factor – and issuers aren’t hiding this fact – are designed to limit downside exposure when markets fall, not capture 100 percent of the upside when equities rally.
Still, investors of all stripe like the idea of reducing equity turbulence. The two largest low volatility exchange traded funds focusing on domestic stocks have over $45 billion in combined assets under management. It’s nice when ETFs pack on assets, but it’s not a determinant of investor outcomes, let alone with a factor-based strategy.
In other words, investors should do some shopping with volatility reduction strategies and not just file into the biggest funds in the group because there are other viable ideas here, including the VictoryShares US Multi-Factor Minimum Volatility ETF (VSMV).
The VictoryShares US Multi-Factor Minimum Volatility ETF tracks the Nasdaq Victory US Multi-Factor Minimum Volatility Index, which is a departure from traditional low vol benchmarks.
Adding Layers to the Equation
One of the issues low vol fans encounter is that many of the old guard indexes devoted to the factor are prosaic in nature and lack depth. For example, components in the S&P 500 Low Volatility Index are measured by trailing 12-month volatility. That’s not necessarily bad, but it’s not a guarantee of favorable outcomes, either. This year, VSMV is topping the S&P 500 Low Volatility Index by 430 basis points.
“Some early iterations of low-volatility strategies accomplish this by simply screening for the least volatile stocks. The drawback of this approach is that these portfolios often have large sector and industry concentrations, making them less appealing to investors looking for diversified market exposure,” according to Nasdaq Global Information Services.
VSMV’s index goes further than rival benchmarks by plugging earnings quality, momentum, profitability, and valuation into the equation. The inclusion of earnings quality and valuation into securities selection process is important because some older low volatility funds can include stocks with less-than-desirable earnings trends and because less volatile stocks often command premiums relative to the broader market. It’s the price investors pay for being defensive.
The Nasdaq Victory US Multi-Factor Minimum Volatility Index’s methodology “results in a portfolio designed to participate in rising or bull markets, while outperforming during periods of heightened volatility or bear markets (best illustrated in the up/down market-capture ratio of the Index),” notes Nasdaq Global Information Services.
VSMV’s multi-factor approach is relevant for another reason: Factor timing its hard. Really hard. For the 13 years ending 2019, low volatility was the best-performing factor on five times. It was also one of the three worst factors on seven occasions, including in three of the past four years.
Another Point in VSMV’s Favor
Another reason VSMV could be a long-term winner for low vol lovers is that its multi-factor approach leads to different sector allocations than rival funds. While first generation low volatility ETFs are designed to be sector agnostic, these products often turn up large weights to consumer staples, real estate and utilities stocks because those sectors are often sport reduced volatility.
That’s a byproduct of weighting solely by price fluctuations. It can also sap returns because those three sectors are usually defensive and slow-moving. VSMV solves some of this issue by allocating 36 percent of its combined weight to technology and consumer cyclical names, groups that are often underweighted in traditional low vol funds.
Traits like those have meaningful impacts on long-term performance. Consider the following. For the 14 years ending 2019, the Nasdaq Victory US Multi-Factor Minimum Volatility Index not only crushed the S&P 500, it beat single-factor strategies devoted to buybacks, dividends, growth, momentum, quality and value – all by wide margins.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
