During one of the most volatile years for U.S. stocks in decades, the least-loved strategy in the $1 trillion world of smart-beta is one aiming to protect investors from the turmoil.
Exchange-traded funds that buy low-volatility stocks are bleeding cash. Not quickly, not in huge amounts, but relentlessly. With more than $1 billion pulled from ETFs using the strategy in October, they’re set for an eighth consecutive month of outflows.
Like so much in markets this year, thank Covid-19 for the eye-opening struggle of products meant to protect against turbulence.
Valuations of these vehicles were at a decade-high coming into the pandemic-fueled crash, yet the strategy failed when needed most -- minimum-volatility shares tumbled even further than the broad stock market in the rout.
In the rebound that followed, many allocators turned their attention toward growth and quality equities.
“If you’re going to add something to your portfolio with the thought that this is going to show up for you in a certain market environment and it doesn’t, that’s a significant strike against that position,” said Matt Miskin, co-chief investment strategist at John Hancock Investment Management. “It was such a beloved factor and now it’s just not as popular.”
It’s a stark change in fortunes for the quant strategy that suggests investors overvalue volatile equities and undervalue stocks that swing less. Buyers flocked because the funds largely delivered. For instance, in 2018’s fourth quarter selloff, low-vol ETFs shed less than half of the S&P 500 Index’s 14% decline.
From July 2018 until February 2020, minimum-volatility ETFs suffered just a single month of outflows en route to amassing $82 billion, according to data compiled by Bloomberg Intelligence. By February 2020, valuations for the factor were the highest in at least a decade.
But throughout this year’s massive swings in the pandemic-induced meltdown, low-volatility stocks actually experienced larger moves, an unusual development sparked by indiscriminate selling in combination with plummeting interest rates.
The S&P Low Volatility Index ended March down 13.4% compared with 12.5% for the S&P 500 Index. That sparked a $3.1 billion exodus from low-vol ETFs that month, and outflows haven’t let up since.
“Investor sentiment changes,” said Hai Vu, portfolio manager for Brentview Investment Management. “That’s the one factor you can’t always capture in all these quantitative measures.”