Love affair with US low volatility ETFs explained

Love affair with US low volatility ETFs explained

Love affair with US low volatility ETFs explained Investors are taking their fascination with low-volatility stocks to new heights.

The PowerShares S&P 500 Low Volatility fund and the iShares Edge MSCI Minimum Volatility USA ETF saw combined assets reach $20 billion this month for the first time, adding $7 billion for the year, exceeding the total for 2014 and 2015 combined. Due mostly to inflows, the market value of the PowerShares ETF jumped by about $1.3 billion this year, while the iShares fund has seen its capitalization roughly double to $13.1 billion.

The inflows highlight a conundrum that has plagued asset managers in 2016: anxiety among clients is skyrocketing and they’re yanking money from the broader market at a time when conventional measures of volatility are below historical averages. Low-volatility ETFs became investor darlings following the dual traumas of August and January and remain one of the only destinations for money even after markets calmed down.

“A lot of investors are trying not to make a mistake right now, so this is the default choice,” said Alan Gayle, a senior strategist at Atlanta-based RidgeWorth Investments, which has about $37 billion in assets. “There’s a lot of anxiety, and in this kind of environment, investors gravitate to what they perceive as safe.”

A $769 million single-day spike last week in the assets of one, the PowerShares S&P 500 Low Volatility Portfolio, reversed the next day and was the result of a quarterly rebalancing rather than investor demand.

Investors are fleeing the rest of the equity market. Clients of mutual and exchange-traded funds invested in US stocks have pulled almost $60 billion this year, poised for the second-highest outflows for any first half since 1984, according to data compiled by Bloomberg and Investment Company Institute.

Obsession with low-volatility stocks has not been without ironic consequences. One is that the shares that make up the underlying indexes are getting more expensive, something that in isolation makes them more turbulent. As a result, the PowerShares ETF is currently showing more pronounced price swings than the SPDR S&P 500 ETF over the past 30 days, Bloomberg data show.

On the bright side, although it’s not necessarily designed for it, the PowerShares fund is beating the market this year. It’s up 3.4 per cent year to date, compared with a 0.2 per cent increase in the S&P 500. All while the Chicago Board Options Exchange Volatility Index, a measure of expected volatility, sits at 15.82, more than 20 per cent below its 10-year average.

Other corners of the market show expectations for volatility that aren’t reflected in the VIX. One is exchange-traded notes that rise when turbulence increases. Over the last 13 weeks, investors have sent an unprecedented $3.5 billion into securities that reap gains from wider price swings.

Investor interest in low-volatility products suggests that even if the market does see a period of price turbulence, it will be short-lived, according to Dan Deming, a Chicago-based manager at KKM Financial LLC

“Even though we saw a couple shocks over the past year, the S&P has been able to find its way back to the 2,050 area,” he said. “Even when you see these flare-ups, there’s anticipation that the market will stabilize again.”

Bloomberg News