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Are Low Volatility Stock ETFs Working?

November 10, 2017 • Posted in Equity Premium, Volatility Effects

Are low volatility stock strategies, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider eight of the largest low volatility ETFs, all currently available, in order of longest to shortest available histories:

We focus on monthly return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using monthly returns for the low volatility stock ETFs and their benchmark ETFs as available through September 2017, we find that:

The following table summarizes sample periods and performance statistics based on monthly and full-sample data for the eight low volatility stock ETFs and their respective ETF benchmarks over available sample periods through September 2017. Notable points are:

  • Monthly return correlations between low volatility ETFs and benchmarks are fairly high, in the range 0.73 to 0.94.
  • Four of eight low volatility ETFs have higher average monthly returns than their benchmarks.
  • All eight low volatility ETFs have materially lower monthly volatilities than their benchmarks.
  • All eight low volatility ETFs have materially higher monthly reward-to-risk ratios (average monthly return divided by standard deviation of monthly returns) than their benchmarks.
  • Six of eight low volatility ETFs have higher CAGRs than their benchmarks.
  • All eight low volatility ETFs have materially shallower MaxDDs than their benchmarks based on monthly measurements.

To summarize, we visualize differences in CAGRs and MaxDDs between low volatility ETFs and their benchmarks.

The following chart summarizes low volatility ETF minus benchmark CAGRs and MaxDDs over available sample periods. Overall, low volatility ETF investors are not sacrificing CAGR and are gaining material crash protection compared to broader stock indexes.

In summary, limited available evidence on attractiveness of low volatility stock ETFs is mostly positive.

 Cautions regarding findings include:

  • Available sample periods are short, especially in terms of variety of market conditions, undermining confidence in findings.
  • Comparing low volatility ETFs to each other based on above data may be problematic when sample periods differ.
  • It is arguable that attractive past performance of low volatility ETFs derives from large inflows of funds to them in recent years. Such inflows may have produced overvaluation conditions among low volatility stocks. Per “Predicted Factor/Smart Beta Alphas”, as of the end of 2016: “Forecasted gross alphas for the low beta factor, and for corresponding low beta and low-volatility smart beta strategies relative to their benchmarks, are negative in all markets.”
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