This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Benjamin Lavine, co-chief investment officer for 3D/L Capital Management in Hartford, Connecticut.
As equity markets, corporate credit, commodities and cryptocurrencies reach new post-pandemic highs amid prospects for global economic reflation, low volatility style of investing seems to have been left by the wayside.
Regardless of whether we’re seeing a shift from large caps to small caps and from “growth” to “value,” as long as the style in question captures higher beta (or higher risk stocks), then it seems to matter little. No one talks much these days about low vol, or funds such as iShares MSCI USA Min Vol Factor ETF (USMV) and the Invesco S&P 500 Low Volatility ETF (SPLV).
Be it record issuance of SPACs, or the outperformance of negative earning companies versus positive earners, or the frenzy around retail trading on platforms offering near limitless margin to trade call options and illiquid OTC stocks, the disdain for volatility protection can be summed up by Figure 1.
It displays the cost of an equity index collar or the premiums paid for index put options versus call options, which have reached multidecade low levels.
Figure 1: Gaga For Call Options As The Cost Of Equity Index Collars Reaches Multidecade Lows
Source: BofA Global Research via The Daily Shot
‘From 2016 Darlings To 2021 Duds’
The appetite for lower volatility strategies seems to have sunk down a memory hole along with August “Volmageddon” of 2019 (noted in “The Year Smart Beta Died?”) and the Brexit vote of June 2016, both periods of time where low volatility experienced significant outperformance only to revert once the market “crisis” at the time had passed.
Who wants lower volatility when the path for higher returns has been made clear by an overly accommodative Federal Reserve willing to keep rates near zero through 2023, and by the Federal government’s upcoming $1.9 trillion stimulus plan?
In addition, lower volatility strategies tend to underperform during a period of rising interest rates, as we noted back in 2017 (“Min Vol ETFs Underperform When Rates Rise”).
We’re not suggesting that low volatility investing is merely an investment fad that has turned from a 2016 Brexit-driven darling to 2021 post-pandemic dud. Low volatility has plenty of academic research documenting the anomaly when seen through risk-adjusted performance. Yet you probably won’t hear much of it discussed in the current market environment.
Low volatility’s unpopularity can be seen through a risk model lens where the “factor loadings” to U.S. momentum are at multiyear negative levels (seen in Figures 2 and 3 for both Minimum Volatility, which captures low risk and low cross-correlations, and Low Volatility, which are pure low risk stocks, as captured by USMV and SPLV, respectively.)
In these tables, we display the estimated sensitivity to various U.S. risk factors as defined by the Bloomberg U.S. Risk Model, with green representing the highest sensitivity and red the lowest sensitivity for each factor across the five-year period starting in March 2016. We highlight two specific periods: Current (2/15/2021) and the height of Brexit fears (6/30/2016).
Figure 2: The Unpopularity Of Minimum Volatility Investing As Seen Through A Risk Factor Lens (USMV)
Figure 3: The Unpopularity Of Low Volatility Investing As Seen Through A Risk Factor Lens (SPLV)
The Quality & Value In Low Vol
We also show the factor loadings to both “Value” and “Profitability” suggest that the fundamentals for Low Volatility look attractive on both a valuation and quality basis relative to recent history.
Finally, we display the sensitivity to “Volatility” itself where the current period demonstrates just how low “Low Volatility” has gotten. Low volatility may be out of favor, but it still reflects a higher quality investment style with one of the lowest risk profiles versus recent history.
The current risk profile of low volatility investing appears almost too good to be true. One would be investing against the tidal appetite for high-risk reflationary assets, but low volatility is priced for peak euphoria rather than peak panic.
At the time of this writing, 3D held positions in USMV and SPLV. The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. 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/L Capital Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete.
Content Not To Be Construed as a Recommendation or Determination of Suitability: The material in this article has been prepared for informational purposes only without regard to any particular user's investment objectives or financial situation. The fact that 3D/L Capital Management has made this information available to you on ETF.com constitutes neither a recommendation to enter into a particular transaction nor a representation that any product described in this article is suitable or appropriate for you. In particular, the fact that a third-party manager or fund is featured in this article should not be viewed as a recommendation or endorsement of such third-party manager or fund.
This article does not constitute an offer to sell or a solicitation of an offer to purchase interests in any investment vehicles or securities. This article is not a prospectus, an advertisement, or an offering of any interests in either the strategy or other portfolios. This article and the information contained herein is intended for informational purposes only. It does not constitute investment advice or a recommendation with respect to investment. Investing in any strategy should only occur after consulting with a financial advisor.
3D/L does not approve or otherwise endorse the information contained in links to third-party sources. 3D/L is not affiliated with the providers of third-party information and is not responsible for the accuracy of the information contained therein.
Past performance is no guarantee of future results. None of the services offered by 3D/L Capital Management are insured by the FDIC and the reader is reminded that all investments contain risk. The opinions offered above are as of February 16, 2021 and are subject to change as influencing factors change.
3D/L Capital management is not offering, and is not authorized to offer, interests in any registered funds. Such offering is made only by prospectus, which is available through FINRA registered broker-dealers.
More detail regarding 3D/L Capital 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/L’s website at www.3dlfinancial.com or from the SEC at https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=669397.