Caution Urged on Low-Vol Strategies

Terry Flanagan

The amount of money invested in volatility reduction strategies is an “accident waiting to happen” according to James Bevan, chief investment officer of CCLA Investment Management.

Bevan spoke on a panel at Markets Media’s European Trading & Investing Summit in London last week. He said: “The huge flow of money into volatility reduction strategies worries me. It is an accident waiting to happen as investors assume that low volatility in the past will be low volatility going forward.”

Low-volatility investing involves buying stocks with relatively less volatile return patterns. The strategy has gained popularity since the 2008 financial crisis and assets have grown more than fivefold.

In March this year there were 72 U.S. fund managers running low-volatility strategies, up from 14 in 2008. Assets under management in the strategy have grown from less than $10bn in 2008 to $54.5bn by March 31 2013 according to Research Affiliates. The PowerShares S&P 500 Low Volatility ETF has attracted $4.3bn of assets between launching in May 2011 and March 2013.

Feifei Lei, head of research, and Jason Hsu, chief investment officer, at Research Affiliates, said in a paper in the Journal of Index Investing that the return for U.S. low volatility strategies since 2008 is 6.1%.

Only two other asset classes had a higher five-year return — high yield with 10.3% and long treasury at 9.7%. Large-cap U.S. equities had a return of 1.7% over the same period.

“As a standalone strategy, low-volatility investing appears to be a sound long-term choice,” the paper said. “In addition, low-volatility portfolios have average correlations of 0.4 to 0.5 with other major asset classes, whereas traditional large-cap equity strategies have average correlations above 0.6.These values indicate that including low-volatility stocks in a broad asset mix may improve overall diversification.”

Related articles