On April 8, Greg Leonberger, director of research, was quoted in a FundFire article on low volatility equity strategies and the sustainability of much hyped optimal risk-return promises. As the article reported, at 14.25% the five-year trailing return of the S&P 500 Low Volatility Index beats that of the standard S&P 500 benchmark at 11.58% by a wide margin. This is leading to a rapid inflow from institutional investors. According to data from eVestment, more than $43 billion surged into low volatility equity strategies between 2012 and 2015, with total institutional assets under management jumping from $48 billion to above $180 billion.
“The first reason investors are moving into low volatility is if you compare returns of low-vol portfolios to their broad market benchmarks, the returns are better and the volatility is lower,” Greg said. “The capital asset pricing model suggests you should get more returns with more risk, but that falls apart with low-vol.”
The article highlighted that part of the compelling risk-return story of low volatility strategies may be due to investor’s collapse of confidence in hedge funds. As Greg explained, rather than keeping money in hedged equity or long-short hedge funds, some investors see low volatility equity as a better alternative.
“Another reason for the growth in low-vol strategies is that a lot of investors view it as the same as hedged equity, though we wouldn’t make that case,” Greg said. “Compared to long-short equity funds, low-vol isn’t shorting stocks. But the idea of doing that is similar—to have equity exposure with lower volatility. And hedged equity has left a lot of upside on the table while charging significantly higher fees.”
Greg doesn’t expect a change in the market conditions that have made for an attractive low volatility narrative any time soon. The unstable macro environment fostered by rising interest rates, unpredictable oil prices and geopolitical uncertainty appears to be here to stay. “Plus, even eight years on, investors are still sensitive to the financial crisis when one bubble blew up the entire market.”
To read the article, visit the FundFire website (subscription required).
For more on Marquette’s position on low volatility strategies, please read The Case for Low Volatility Investment Strategies. For more on hedged equity, please read Hedged Equity: What Happened to the Alpha?
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