Low- or minimum-volatility ETFs have been one of the big smart beta success stories over the past few years, drawing in significant asset flows and satisfying investors with their appealing risk-returns profiles. In recent months, however, such ETFs have, to the consternation of investors, started to appear to display higher volatility compared to their comparable mainstream equity indices.
“The basic goal of these strategies is to limit losses on the downside, while capturing a decent chunk of the upside,” said Barbara Wall, Europe managing director at global research and consulting firm Cerulli Associates.
“For a long time, the products did exactly that. But in the second half of 2016, it all started to go wrong, with a raft of statistic showing that so-called ‘min-vol’ products had higher volatility than the mainstream indices over long periods.”
Despite the funds not delivering on their stated objectives, Wall advises investors to be patient, noting that smart beta strategies are designed as long-term holdings.
With overall market volatility having been very low by historical standards in recent months, Cerulli notes that firms operating in the volatility-based arena will argue that the strategies have worked for long stretches and that the recent bad run is merely an aberration.
“They will have a point”, added Wall. “As the old cliché goes, markets don’t go up in straight lines. Gaining from smart beta’s outperformance may take patience. Smart beta will not work every time. But if it can work at least some of the time, it can help enhance returns, and should continue to play a part in the portfolios of investors, especially those with realistic expectations.”
While Cerulli’s advice may allay some investors’ fears, investors are beginning to vote with their feet, with low-volatility ETFs beginning to experience outflows. With the strategy having lost some of its kudos, ETF issuers and index providers will need to work harder to convince investors and advisors that such strategies are worth including in portfolios.