A Scientific Approach to Lowering Beta | ETF Trends

Low volatility is one of the most prominent investment factors and that much was on display last year as investors flocked to ETFs adhering to reduced beta methodologies, but sometimes, it can help to add some science to the factor.

The Global X Scientific Beta US ETF (NYSEArca: SCIU), which is part of a broader suite of ETFs with similar volatility reducing capabilities, does just that.

Additionally, Global X offers a line of scientific beta ETFs that are based on EDHEC-Risk Institute indices that target multiple factors, including low-volatility, momentum, size, and value. The indices also combine the five models, including Maximum Deconcentration, Maximum Decorrelation, Efficient Minimum Volatility, Efficient Maximum Sharpe Ratio, and Diversified Risk-Weighted.

SCIU, which turns five years old in May, follows the Scientific Beta United States Multi-Beta Multi-Strategy Four-Factor Equal Risk Contribution (ERC) Index. The fund can help investors avert some of the drawbacks associated with low volatility investing.

“While certain defensive strategies can reduce volatility and outperform broad indexes during bear markets, investors must take into account the concentration risks they can introduce,” said Global X in a recent note. “For example, looking at just a subset of stocks that historically exhibited lower volatility than the market means that Low Vol strategies can be heavily concentrated in certain sectors, like Utilities and Consumer Staples.”

Side With Science

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.

Low risk refers to beta or volatility, with a preference for stocks with low risk over those that exhibit wider swings. The size factor may cause a strategy to tilt toward small-caps over large-caps as a way to capture a premium in smaller companies.

Value stocks look at those with high versus low book-to-market and other valuation points. Momentum considers stocks with high versus low returns over the past 12 months, with an outlook that outperforming stocks may continue to maintain momentum and outperform. The profitability metric targets stocks with high profitability or return on equity or gross profitability. Lastly, the investment factor is defined by the allocation of various assets classes and categories.

“Rather than isolating exposure to just the Low Vol factor, multi-factor strategies can blend the defensive characteristics of Low Vol with other factors with their own unique characteristics such as Momentum, Size, and Value,” according to Global X. “Sci Beta, for example, blends the aforementioned four factors together in an effort to deliver more robust returns over the long term and across different market environments.”

For more news and strategy on the Smart-Beta ETF market, visit our Smart-Beta category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.