Low Vol Factor: From Obscurity to Stardom

Has Low Vol Changed Given the Rise in Popularity?

August 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Given the popularity of Low Volatility, investors might expect structural shifts in the factor characteristics
  • Betas, valuations, sector biases, interest rate sensitivity, and factor exposures are highly time-varying
  • Although these are worth monitoring from a risk perspective, none seem particularly concerning currently

INTRODUCTION

Germans call a product or service that solves all problems without any compromises a “Eierlegende Wollmilchsau”, which literally means egg-laying wool-milk-pig. Naturally there are few items, if any, that can achieve such a status, although the Swiss might have come close with their multi-functional Swiss army knife, which has proved so useful that even NASA used it in space missions.

Investors are perpetually looking for equivalent products in the investment world. These should feature high returns and low risks. Low Volatility strategies are often thought of approximately providing such desirable characteristics and became popular after 2009 as a portfolio of low-risk stocks experienced a significantly lower drawdown than that of the stock market during the global financial crisis.

The interest has remained strong in recent years as highlighted by the iShares MSCI Min Vol US ETF (USMV), which gathered approximately $6 billion in assets and accordingly became the third-most popular ETF in the US in the first half of 2019. However, although a certain amount of interest in a strategy is needed to generate positive performance, too much can cause crowding and the factor to trade at expensive valuations (read Low Volatility: High Factor Valuation). 

In this short research note, we will investigate if the Low Volatility factor has changed structurally over the last 30 years as its status changed from obscurity to a common staple in investment portfolios.

METHODOLOGY

We focus on the Low Volatility factor in the US stock market. The factor performance is calculated by constructing a long-short beta-neutral portfolio of the top and bottom 10% of stocks ranked by their 12-month volatility. Only stocks with a minimum market capitalization of $