Invesco’s Nick Kalivas on low volatility for the long term
Nick Kalivas, Senior Equity ETF Strategist at Invesco, has fielded a number of questions about the potential performance of low-volatility ETF strategies in the recent weeks.
But there is a caveat, says Kalivas. “While the strategy tends to generate excess returns when the stock market is performing poorly or there is great deal of risk in marketplace, it is still important to view low volatility for the long term. If you’re expecting it to be a cash or bond substitute, the greater the chance you will have of disappointment.
Kalivas has found that in recent weeks, performance is in line with what they have seen historically. However, the down capture has been at the higher end of the range.
As a long equity strategy, low volatility tends to have varying performance in different market conditions, explains Kalivas. When investors are looking to have exposure to low volatility stocks, they are trying to harvest the low volatility anomaly over a longer time horizon. Over time, lower risk stocks tend to outperform higher risk stocks.
A recently published S&P Dow Jones Indices white paper, ‘S&P 500 Low Volatility Index: Five Decades of History’ found that in the last five decades, low volatility indices have typically outperformed their underlying broad market benchmarks on both an absolute and a risk-adjusted basis. This is contrary to traditional finance theory which ascertains that higher risk stocks achieve higher returns.
“The anomaly remains just as relevant today and we can see that low volatility in the current environment is acting in line with what it has done historically,” offers Kalivas. “There is also this feeling that low volatility is very interest rate sensitive in terms of performance, but research shows that interest rates may have some influence, but the biggest driver is in the direction of the market – be it up or down.
According to S&P DJI, the analysis demonstrates that the effect of interest rates changes on low volatility performance is conditional on the directional change in the equity market. For example, the low volatility index typically underperformed by an average of 1.24 per cent (1972 to 2019) when the market and rates both rose. Furthermore, the low volatility index typically outperformed when rates rose and the market fell. Conversely, when rates declined, the low volatility index typically trailed the S&P 500 when the market rose, and it outperformed when the market declined.
Kalivas points out that since inception in 2011, SPLV has delivered 9.13 per cent and year-to-date (24 March, 2020) has delivered -25.43 per cent. Assets under management currently stand at USD8.56 billion.
Currently, the three largest sector exposures are utilities (28 per cent), REITS (18 per cent) and financials (16 per cent), with less than 1 per cent of the ETF allocated to energy.
“On average and over time, utility stocks tend to be a strong allocation because they have low volatility, but it doesn’t have to be that way,” Kalivas says, explaining that with SPLV, there have been periods where exposure to financials has ranged from less than 3 per cent to over 30 per cent. “It is purely based on what is going on with the members of the S&P 500 and the trailing volatility.
“Low volatility ETFS are long equity strategies. They are not structured products and do not use derivatives. Their performance can vary on a day to day basis.”