Low-volatility stock exchange traded funds are outpacing the benchmark S&P 500 index as conservative plays weathered the market correction in October and kept performing, but some warn of an overcrowded trade.
Year-to-date, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) gained 17.3% and iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) rose 16.9%, whereas the S&P 500 index increased 14.3%. [ETFs to Capture the Low-Volatility Anomaly]
The low-volatility strategies underperformed last year as a steady bull rally propelled U.S. equities. However, a rise in volatility this year has helped the least volatile stocks standout this year.
Harindra de Silva of Analytic Investors argues that the low-volatility strategy will continue to do well if the CBOE Volatility Index moves toward the 20 level – the VIX currently sits at around 15, reports John Authers for Financial Times.
Additionally, de Silva argues that low-volatility equities are experiencing greater demand due to low interest rates. Traditionally, investors would turn to fixed-income assets to diminish risk exposure. However, with rates more likely to rise and the U.S. economy expected to continue expanding, investors have turned to low-volatile stock options to capture a growing equities market and to hedge some of the market risks.
For instance, both SPLV and USMV overweight outperforming defensive sector stocks. Specifically, SPLV includes a 18.1% tilt toward utilities and 16.6% in consumer staples. USMV has 19.6% healthcare and 14.5% consumer staples. Both ETFs also underweight the energy sector, the worst performing area of the market so far this year.
However, some are growing concerned that these low-volatility investment strategies may be overcrowded.
Andrew Lapthorne of Société Générale warns that earnings multiples on low-vol stocks are hovering around the top of their historical range and their price-to-book are trading at a premium to the broader market. For instance, SPLV has a 19.6 P/E and a 2.5 P/B and USMV has a 20.2 P/E and a 3.1% P/B, whereas the S&P 500 index shows a 17.6 P/E and a 2.4 P/B.
Additionally, Lapthorne points out that financial stocks are now the largest component of the lowest volatility quintile of the MSCI World Index, and these financial stocks could grow more volatile as the market heads into a period of greater interest rate uncertainty. Financials make up 32.9% of SPLV and 19.6 of USMV.
For more information on low-vol strategies, visit our low-volatility category.
Max Chen contributed to this article.