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Why Low-Vol Strategies Make Sense Now

by: Lawrence Hamtil     

2017's strong market resulted in the largest outperformance for the S&P 500 index versus its low-volatility counterpart since 2013:

In fact, last year saw the S&P 500 low-volatility index fail to outperform all but a handful of the other factor benchmarks, trailing the growth and momentum indices by more than 10% each (via SPIndices):

Largely as a result of this relatively poor performance, assets have been bleeding from the popular ETFs that track the S&P 500 and MSCI low-volatility indices.  With the market off to another strong start in 2018, it would not be surprising to see even more investors exiting low-volatility strategies.  

However, as a long-time proponent of low-volatility investing, I would not encourage you to follow suit.  There are many advantages to low-volatility strategies such as the consistency of their returns, about which I wrote last summer.  Additionally, low-volatility strategies have generally suffered shallower drawdowns with shorter durations than the broader market:

Furthermore, while investors may be inclined to think that risk necessarily equals more reward, the opposite is true in this case; since November of 1990 (the earliest point for common data), the S&P 500 Low-Volatility Index has outperformed the S&P 500 Index by 80 basis points annually, with 70% upside capture, but only 50% of the downside capture:

Importantly, since 1995, low-volatility has more or less performed in-line with last year's best performer, momentum, with quite favorable risk-reward characteristics:

In light of these comparisons, investors would be wise to reconsider abandoning low-volatility strategies, especially now that the market is, by almost any measure, expensive, and volatility has been uncharacteristically benign for so long.  Low-volatility investing should continue to be a good way to maintain exposure in an expensive market while being positioned advantageously for the inevitable correction.

NOTE:  For anyone interested in investing in low-volatility strategies, it is important to understand that there are vast differences between some of the more popular low-volatility indices and the ETFs that track them.  For example, relative to the broader market, the MSCI low-volatility ETF (symbol USMV) deviates less from the S&P 500 sector composition (as measured by the SPDR ETF, SPY) than does the S&P 500 low-volatility ETF (symbol SPLV), as can be seen in the graphic below (data as of January 2018):

Clients of Fortune Financial Advisors, LLC own USMV.

The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.

Lawrence Hamtil is a fourteen-year veteran of the financial services industry, having served clients in all aspects of the business during his career, which started in 2002. In 2005, he joined Dennis Wallace of Fortune Financial Services, LLC, becoming, at the time, one of Multi-Financial Securities, Inc's youngest registered representatives. In 2008, Dennis and Lawrence made the decision to become fully independent by founding their own Registered Investment Advisory (RIA), Fortune Financial Advisors, LLC. He serves clients in the United States and Europe. His financial commentary has been referenced in Barron’s online edition.

You can connect with Lawrence on Twitter ( @lhamtil) or via email, lawrence.hamtil@fortuneadv.com.