"I think they are definitely onto something, but I don't think they will be able to duplicate Buffett's performance," Lee says. "They have captured some part, but not the totality of Buffett's acumen in a mechanical strategy."
AUEIX is designed to capture this out performance. Lee likes AQR's top notch academic staff and strong track record in quantitative strategies, but notes their fees--75 basis points for AUEIX and 90 basis points for the AQR International Defensive Equity (ANDIX) fund--are more than twice the cost of the iShares and PowerShares ETFs. Both of these funds launched in July 2012. AUEIX is up 3.8% and ANDIX has returned 7.2% since inception--both lagging their benchmarks.
Getting Too Popular?
While the low volatility approach has an impressive academic pedigree and the imprimatur of respected industry analysts like Morningstar, it has its critics. For Andy Kapyrin, research director at RegentAtlantic Capital in Morristown, N.J., a financial advisory firm with $2.2 billion in assets, these products may be victims of their own success in the current market environment.
"You have to consider that markets are dynamic, and that there are good and bad times for all strategies, and frankly I don't think today is the right time for low volatility investing," says Kapyrin, whose firm began researching volatility reduction strategies after the market crash in 2008.
Kapyrin sees two reasons why the low volatility approach may be less successful going forward--popularity and valuation. "As more people become aware of the anomaly, investors will arbitrage it away, and the anomaly will no longer provide the same benefit to your portfolio as in the past," he says.
"In addition, since 2008, investors have been chasing lower volatility products, flocking to bonds and over weighting high quality stocks. So these safe companies have become over owned. J&J and Proctor & Gamble trade at 22 times earnings versus a market trading at 15 times. In 2000, these companies traded at a discount to the market."
Kapyrin says his firm has chosen to use fundamental index products based on valuation to reduce risk instead.
Kapyrin also notes that these low volatility products have high tracking error and sector concentration. Looking at the top three sectors for both the low volatility indices and the S&P illustrates this point. The S&P Low Volatility Index has 31% exposure to consumer staples, 29% to utilities, and 15% to healthcare. In contrast, the S&P 500 has a 20% weighting in information technology, 15% in financials, and 12% in healthcare.
Kapyrin believes these different weightings help contribute to tracking errors that ranges from 10%-15%, which he considers unacceptably high.
Low-beta strategy funds are relatively new and don't have much of a track record, and it remains to be seen if actual longer-term results will match the long-term results from Bradley, Baker and Wurgler that shows an additional 2% of alpha a year in a multi-decade backtest.
The oldest mutual fund in this group, the SEI US Managed Volatility (SEVIX), which was launched in mid 2007, has garnered a five-star rating from Morningstar. SEVIX has returned 2.7% annually over the past five years, besting the S&P 500's annual return of 1.12% during that period. Meanwhile, it took on less risk than the index--its beta over that timeframe has been 0.77.