Call it the revenge of the anti-meme stocks. I’m referring to low-volatility stocks’ huge alpha so far this year: Through Sep. 8, according to FactSet, the iShares MSCI USA Min Vol Factor ETF
has fared better than the S&P 500
by 5.7 percentage points. (Calculations take dividends into account.)
Meme stocks, in contrast, which are at the opposite end of the volatility spectrum, have been decimated this year so far— despite headline-gathering rallies here and there along the way. A representative portfolio of 16 popular meme stocks that Morningstar created in 2021 has lagged the S&P 500 this year by 35.8 percentage points.
That means there is a year-to-date spread of more than 40 percentage points in favor of low-volatility stocks over meme stocks.
Does this huge outperformance mean that low-volatility stocks are once again in favor? It’s important to ask since, despite an impressive long-term record, this stock-picking approach struggled for a number of years prior to 2022. Some even wondered if the approach had permanently stopped working.
For insight, I reached out to Nardin Baker, Chief Quantitative Analyst for Wise Responder. Baker was the co-author (with the late Robert Haugen) of some of the first academic studies documenting the historical performance of low-volatility stocks. Perhaps the best-known of those studies — Low Risk Stocks Outperform within All Observable Markets of the World — showed that the low-volatility effect existed in each of 33 different country stocks markets over the period from 1990 through 2011.
Many argue that low-volatility stocks’ large positive alpha this year can be traced to the value sector retaking the lead over growth, after many years of lagging. But that can’t be the explanation, Baker argues, because low-volatility portfolios currently are heavily weighted with growth stocks. So, if anything, low-volatility portfolios’ growth tilt has hurt these portfolios’ returns this year.
This in turn means we need to look elsewhere than high inflation and the Federal Reserve’s interest-rate policies for the cause of low-volatility stocks’ alpha this year. While both factors are typically good for value stocks’ relative strength, they would have helped low-volatility portfolios this year only if they were dominated by value stocks. But, once again, they’re not.
Low-volatility portfolios’ skewness towards the growth end of the value-growth spectrum represents a shift from several years ago. Currently, for example, the iShares MSCI USA Min Vol Factor ETF’s P/E ratio is higher than the S&P 500’s, and so is its average price/book ratio. Five years ago both of these measures were below.
This tilt towards growth illustrates one of the underlying virtues of the low-volatility strategy: It adapts to changing market conditions, shifting away from more volatile stocks and into ones exhibiting greater price stability. For much of U.S. market history value stocks were those stable examples, but this began to change several years ago.
The lowdown on low volatility
Adaptability is just one reason to favor low-volatility stocks. Another is that the approach enables you to participate in the stock market with less anxiousness than your fellow equity investors.
That’s because relative volatility persists. A low-volatile stock tends to continue being less volatile, while a high-volatile stock tends to remain highly volatile — as the meme stock phenomenon so well illustrates.
This assumption has been amply documented over the years. The iShares MSCI USA Min Vol Factor ETF’s trailing 3-year beta currently is 0.78, for example. Its beta would be 1.0 if past volatility were only randomly related to future volatility.
This feature of a low-volatility portfolio is especially valuable right now, Baker argues, since market uncertainty is unusually high. Low-volatility stocks can provide a measure of stability in the midst of the market’s chaos.
The iShares MSCI USA Min Vol Factor ETF is the low-volatility ETF that currently has the most assets under management, at $28 billion. Others include the Invesco S&P 500 Low Volatility ETF
with $11 billion under management, and the Vanguard U.S. Minimum Volatility ETF
with $70 million.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org
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