Low-Volatility Strategy is Effective in Bond ETFs Too

Academic research and investors have found that equities exhibiting low volatility have outperformed over the long-haul by diminishing drawdowns during sell-offs while still allowing investors to participate in any upside potential. The same low-volatility effect can also be applied to fixed-income exchange traded fund investments to improve long-term returns too.

“The low volatility effect in equities has been well documented in academia for decades,” S&P Dow Jones Indices’ Hong Xie, director of global research and design, and Aye M. Soe, senior director of global research and design, said in a note. “Our research shows that low risk investing can be applied to fixed income as well.”

Many have studied the effects of low-volatility factor on equity performance. For instance, more recently, Blitz and Vliet (2007) constructed decile portfolios based on the rankings of stocks by their three-year realized volatility, revealing that the volatility of the top decile portfolio, which contains the low risk stocks, was about two-thirds of the market volatility, whereas the volatility of the bottom decile portfolio had a standard deviation that was almost twice that of the market. The researchers basically found that the top performers consisted of low-volatile stocks that exhibited low volatility and the bottom performers showed swings twice as severe as the broader market.

Given the beneficial qualities of a low-volatility focus on the equity side, some are beginning to consider the low-vol factor for inclusion in fixed-income portfolios. For instance, Carvalho, Dugnolle, Lu, and Moulin (2014) looked to the low volatility factor across major developed fixed income markets and discovered lower risk bonds generated positive alpha, irrespective of the currency or market segment that they considered.

Given this backdrop, IndexIQ recently rolled out the IQ S&P High Yield Low Volatility Bond ETF (NYSEArca: HYLV) to help investors gain a smoother ride in a traditionally riskier segment of the debt market.