After a bout of politically induced market volatility, exchange traded funds that track low-volatility strategies continue to outperform.
Over the past month, the iShares Edge MSCI Min Vol USA ETF (NYSEArca: USMV), which selects stocks based on variances and correlations, along with other risk factors, rose 4.4% while the competing PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), which tracks the 100 least volatile stocks on the S&P 500, increased 5.1%. In comparison, the S&P 500 index dipped 0.3%.
The low-volatility factor investments work on the idea that they help cushion against market turns, limiting drawdowns that investors experience while providing upside potential. Consequently, the low- or min-vol strategies may produce better risk-adjusted returns over the long haul, which has been backed by extensive academic research.
Related: Slow-and-Steady ETFs for a Volatile Market
However, after outperforming for most of the year, some may be wary of valuations within the low-volatility benchmarks. For instance, unlike the main MSCI US Index, the MSCI US Minimum Volatility Index is at an all-time high, reports John Authers for the Financial Times.
The minimum volatility index is trading at a valuation premium or a price-to-earnings multiple 9% higher than the market. In contrast, it has traded in a range of from 26% discount in 2002 to a 28% premium at the market nadir in 2009.
[related_stories]MSCI, though, pointed out that the min-vol index is within one standard deviation of its historic premium to the market, so the strategy is not too overvalued, yet.
Consequently, the chances of the strategy falling off ahead is more likely. Nevertheless, there is a chance of a more serious market plunge, which could cause the min-vol strategy to shoot up, with valuations growing to a much higher premium.
Related: A Defensive Sector ETF for Volatile Summer Months
Supporting the low-vol performance, MSCI pointed to beta, the degree to which stocks tend to move in the same direction as the market, along with dividend yields. Low-vol ETFs have been strengthening this year as they limited downside risk when the markets slipped and strengthened on increased defensive bets during turbulent times.
For more information on the low-vol strategy, visit our low-volatility category.