The bottom line is that assessing whether or not a particular exposure or strategy is attractive should include consideration of the many factors that drive valuations in the first place. Most importantly, however, investors should keep in mind that the case for including a minimum volatility strategy in a portfolio is not based on whether its valuation is attractive or not at any given moment. Instead, the key idea behind these strategies is to reflect market behavior that is additive to a portfolio and diversifying to a “traditional” investment style.
I have argued that behavioral biases as well as institutional constraints are a key driver of the “low beta effect” that is behind the better return per unit of risk that minimum volatility strategies have shown in the past. In fact, the MSCI USA Minimum Volatility Index has been more “expensive” than the standard benchmark every month since the end of 2011, but it has nevertheless delivered better returns per unit of risk as compared to the standard cap-weighted benchmark [3].
Daniel Morillo, PhD, is the iShares Head of Investment Research.
[1] Valuation ratios as computed as Price divided by EBITDA. Index-level valuation data is from Bloomberg for the standard MSCI country indices. EBITDA is a standard choice for cross-sectional analysis as it is generally less prone to large observations as simple bottom-line earnings.
[2] The chart shows all developed countries where their standard MSCI index contains 20 or more names. Index-level data for ROA is from Bloomberg as of May 28. ROA at the index level is computed aggregating Earnings and Assets separately and then dividing the sums.
[3] Data is from Bloomberg. Annualized returns from monthly data for the MSCI US index since end-December 2011 until end-April 2013 are 16.3% with annualized risk of 9.9% for a Sharpe ratio of 1.64. The equivalent numbers for the Minimum Volatility index are 17% annualized returns, 7.6% annualized risk for a Sharpe Ratio of 2.23.