Citywire printed articles sponsored by:
View the article online at http://citywire.co.uk/wealth-manager/article/a700752
Can low volatility strategies deliver?
by David Campbell on Sep 11, 2013 at 00:01
Volatility management strategies have expanded aggressively in recent years, catering for a generation of investors traumatised by the historic spike of 2008 and periodic eruptions since.
While anecdotal evidence suggests some volatility strategies planned for launch this year have failed to get off the ground as the Vix dropped back to a six-year low, with the index rising sharply again, investors’ thoughts may once again be turning to methods of managing it.
Total assets under management in global sector strategies have increased almost seven-fold in the last three years, according to consultant eVestment, from $8.65 billion (£5.5 billion) to $58.47 billion.
‘Low volatility equity investing has attracted serious interest from the investment community recently,’ said Feifei Li, director and head of research at RAFI index producer Research Affiliates.
‘[But] its popularity has led consultants and institutional investors to express doubts regarding the valuation level for low volatility stocks after seeing rapid flows into this arena.’
After steadily declining from October 2012 through to March this year, volatility has returned to a more familiar recent pattern of peaks and troughs. After spiking to above 20 in the June sell-off, the Vix has been rising steadily since early August, from 11.84 to 16.32.
This has not been matched by any sharp decline in equity prices, however. The S&P 500 is off little more than 3.2% over the same period, with Li warning the effectiveness of ‘naïve’ volatility strategies would inevitably be hampered at a relatively full-priced entry point.
‘Clearly, it does not make sense to invest in low volatility strategies that are poised to experience low returns because the low volatility stocks are trading at high valuation multiples,’ she said.
Rather than isolate inverse return characteristics, such as inverse beta or volatility equally, which results in over-diversification and outsized scale and turnover, she suggested adding a second screening criteria, such as book value of equity.
‘[This] increases the investment capacity of the strategy, reduces trading costs, and shifts the portfolio toward more value-oriented firms.
‘More directly, omitting stocks with low book-to-market value ratios (the top half of the selection universe) increases allocation to value (HML), yielding higher return without sacrificing the Sharpe ratio.’
News sponsored by:
Today's top headlines
More about this:
On the road
by Alex Steger on Dec 11, 2013 at 10:19