As my colleague Ugo Egbunike and I pointed out in our blog 'Why
Low Volatility Is Losing Its Alpha,' SPLV had a bad week on the
heels of serious corrections in high-yielding utilities stocks.
Returns of the PowerShares S&P 500 Low Volatility Portfolio
(NYSEArca:SPLV) versus those of its parent index, the S&P 500,
suddenly look unappealing. After a long run of outperformance,
low-volatility funds have fallen out of bed with a thud.
The telltale sign of a bubble?
The hallmark of low volatility is underperformance during market
bubbles, and outperformance when the bubbles burst.
The chart below shows the rolling 12-month returns difference
between the S&P Low Volatility Index and its parent, the
S&P 500 index.
The low-volatility strategy took it on the chin during the
Internet bubble, but delivered in spades after the dot-com bust,
only to drop again after the market bottom in 2002. Low volatility
was a good refuge during the housing bubble crash, but lagged badly
during the initial phase of the recovery.
The recent underperformance of low vol might signal the onset of
another market bubble.
The principle 'the observer affects the observed' could be at
Simply put, after the housing crash, playing defense is the new
offense, and investors have been piling in. Many portfolio managers
have hopped on the defensive bandwagon, adding allocations to
high-yielding dividend stocks and to low volatility. In the
process, a strange thing has happened to low volatility
valuations-they're really not cheap anymore.
As of May 2, 2013, U.S.-focused large-cap and total-market
volatility funds have posted some chunky price-to-earnings (P/E)
|MSCI USA Investable Markets Index
|MSCI USA Large Cap Index
|iShares MSCI USA Minimum Volatility Index Fund (
|SPDR Russell 1000 Low Volatility Fund (
|PowerShares S&P 500 Low Volatility Fund (
Indeed, SPLV's and LGLV's P/E ratios are notably higher than
those of their parent index's large-cap universes. To be fair, the
Russell 1000 dips well into the midcap space by many definitions,
but excludes small-caps. Even compared with the overall U.S. equity
market, LGLV looked expensive.
This wasn't always so.
Historically, low-volatility portfolios have carried low P/E
ratios-so much so that academics have argued about whether low
volatility is a separate anomaly from the value effect, or if they
are two sides of the same coin. Could the recent uptick in
low-volatility P/Es be a telltale sign of a low-volatility
Is low volatility, in fact, just low volatility?
Low volatility could just be doing its job, which is to reward
investors during volatility spikes.
Take a look at this chart, which superimposes the 12-month
rolling difference in returns to the S&P Low Volatility
strategy versus the S&P 500, and the trailing 30-day realized
volatility of the S&P 500 index:
Don't forget to check IndexUniverse.com's ETF Data
2013 IndexUniverse LLC
. All Rights Reserved.