Invesco’s low and high volatility ETFs shine bright light on volatility path behind and maybe path ahead
May you live in interesting times is, famously, a curse, but a low volatility ETF from Invesco, the S&P 500 Low Volatility ETF (SPLV), has sailed through some 10 years of ‘interesting times’, and its performance provides an interesting overview of market volatility over that period, and along with its higher volatility sibling, SPHB, might even provide a little opportunity to forecast what lies ahead.
Since inception SPLV has experienced 19 per cent less volatility, 11.03 per cent v 13.65 per cent, a beta of 0.65, compared with the S&P 500, and the Sharpe Ratio has been above the S&P 500 at 1.04 compared to 1.01 since inception in May 2011. In terms of striking market rallies and limiting sell offs, it has had a 69.7 per cent up capture and 55.9 per cent down capture ratio.
In terms of performance, SPLV has outperformed the S&P 500 by an average of 3.90 per cent (-6.24 per cent to -10.14 per cent) in 19 of 21 periods where the S&P 500 declined by 5 per cent or more with a 90.5 per cent win rate (19 of 21 occurrences). Prior to the pandemic sell off SPLV did outperform the S&P 500 by 15 bps (13.66 per cent v. 13.651 per cent) from 5/5/2011 to 2/19/2020.
However, the two times in which SPLV failed to do its stuff were during the ‘taper tantrum’ in May 2013, and last year, when the down capture hit 105 per cent during the pandemic sell off, and SPLV also missed out on the subsequent strong bull market rally.
Nick Kalivas (pictured), head of factor and index strategies at Invesco, explains that a lot of this was to do with unlucky market timing and extraordinary market conditions. During the February to March period at the heart of the beginning of the pandemic, there was a shift in the volatility structure of the market, Kalivas says.
“A number of the stocks that had screened as low volatility going into the third Friday of February rebalance, became higher volatility and the higher volatility stock had some of their volatility come down again, because they were essentially companies that would help us all get through the pandemic and became more stable and coveted and it brightened their performance.”
While the process behind SPLV is quantitative, there was something of a change in the regime of the market in the way that the numbers started to play out, Kalivas says.
“One of the unfortunate dynamics for the low volatility suite SPLV ETF was that it had just done the rebalance on the third Friday of February, based on the data from the last business day of January, so it couldn’t make an adjustment until the next rebalance in May.”
SPLV was stuck holding those stocks that had picked up volatility. “One way to describe that is that the factor moved away from the fund holdings and it was reunited in the May rebalance,” Kalivas says.
“May was a very historic rebalancing with 64 additions and deletions, so a big turnover compared with a more recent turnover of eight to15. It was the pandemic and its impact on the volatility structure that created such a headwind,” he says.
“There have been those two periods in the fund’s 10 history and I think that one was the pandemic and the other was the spring of 2013, during the ‘taper tantrum’, so pretty unique events for a long only strategy but the batting average is pretty good because the other 19 times when the market sold off by 5 per cent or more it did provide good downside market capture.”
Now, SPLV might again be revealing the growing amount of volatility in the market. “At the moment, it’s interesting that over the last few weeks you have actually seen a pick up in its relative out performance,” Kalivas says. “It has acted more as one might expect given this recent sell-off that has taken place and some of the strength of the bull market has subsided or stalled.
“Back in February, it started to bottom on a relative basis and now it’s on the top end of that performance range, so improved performance as we have seen the market churn up a bit here in recent months, almost ahead of some of the market’s recent consolidation.”
Kalivas believes that this is in response to the desire for risk taking by investors in the market that has been exhibited through the spikes in online trading accounts focusing on frothy, growth-filled individual stocks. “There has been lots of call buying relative to put buying, with so much focus on risk taking,” he says.
“It feels like the market is over embracing risk and or overpricing risk which could work in the favour of the fund going forward. Some investors treat those risky stocks as lottery tickets and they are over priced and that is where low volatility can shine in the aftermath of that pricing dynamic.”
SPLV has USD8 billion in assets, and in terms of flows, has been relatively flat since early March.
“What makes me optimistic if you look at the trailing flows is that they line up with the 12 months trailing return and those flows kind of reverse at extremes, as does the performance, so it feels like if you are a contrary investor, we could be at an inflexion point.”
Kalivas says that an interesting conclusion one might draw is the we are now facing a period of volatility. “That could fit in with this idea that investors are embracing too much risk but within our breadth of products we have SPHV, the high volatility fund, which has outperformed the low volatility fund,” he says.
“I think that the differential in return is pretty extreme and fits into the idea that investors have been loving risk and that might predict better times for a market more risk adverse going forward. I think this is one of the seasonally difficult times which falls into the adage ‘sell in May and go away’. It’s quite possible - we will see.”
If high volatility does hit, SPLV will be better positioned than before, he says. “The pandemic was such an odd experience and even the ‘taper tantrum’ was unusual. I do think that SPLV will be better positioned and over time it does have a strong track record.
“If you gave up on SPLV back in May 2013, you would have missed out on that risk mitigation for 11 periods where the market sold off so the times where it doesn’t work are more of an outlier.”