- USMV has an equity beta of 0.80, while SPLV has an equity beta of 0.73. These are consistent with what you would expect from this portfolio, with SPLV having lower risk than USMV, given the former's construction methodology.
- USMV has a forecasted tracking error (or active risk) of 4.6% versus the S&P (meaning that USMV is expected to perform within +/- 4.6% versus the S&P over a majority of one-year periods), while SPLV has a projected tracking error of 6.0%. Again, this is consistent with SPLV's construction methodology allowing for greater sector deviations.
- Breaking down the sources of active risk, the majority come from industry risks, as would be expected, given the large relative sector weights.
- However, the factor exposure breakdown gives a more interesting story. Apart from "size" or smaller-cap risk exposure, Bloomberg's risk measure of low volatility is the primary contributor to SPLV's overall risk-factor exposure, followed by momentum, earnings variability and growth. For USMV, momentum serves as the primary contributor, followed by low volatility and value.
By conducting an X-ray on low-volatility ETFs, investors can get a more granular picture on what it is they are buying. SPLV represents a purer play on low-volatility investing, while USMV represents a meaningful play on low volatility, but tempers this exposure through commonsense guardrails such as sector constraints.
Don't Bet Only On Low-Volatility Investing
Personally, if I had to bet on what strategy will perform 12 months out, the contrarian in me leans toward value investing over momentum and low volatility, given the popularity of the latter two.
Indeed, we've seen a bit of this reversion play out in March and April. But the near-term matters little when incorporating alternative betas into a broad equity strategy designed to capture long-term risk premia.
Academics struggle with the low-volatility anomaly because it turns capital asset pricing models on their heads (investors should be compensated with excess premia for taking on higher risk, not the other way around).
In an environment of low anemic growth and weak inflation, low-volatility investing remains the preferred method of gaining market exposure. But just as Cliff Asness advised, one should not bet solely on a single factor or strategy, but incorporate it as part of a diversified portfolio.
At the time of this writing, 3D Asset Management held SPLV and USMV. The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes and opinions of others are assumed to be true and accurate; however, 3D Asset Management does not warrant the accuracy of any of these. There is also no assurance that any of the above is all-inclusive or complete. Past performance is no guarantee of future results. None of the services offered by 3D Asset Management are insured by the FDIC, and the reader is reminded that all investments contain risk. The opinions offered above are as of May 9, 2016, and are subject to change as influencing factors change. More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm's Form ADV Part 2, which is available upon request by calling (860) 291-1998, option 2, or emailing [email protected] or visiting 3D's website at www.3dadvisor.com.