Many analysts predicted extended periods of heightened market volatility in 2016 – both after the Brexit referendum in June and when US President Donald Trump was elected in November.
Global investors withdrew $600 million from low volatility ETFs in January amid calm markets.
Although uncertainty lingers, any significant disruption was fleeting. US stock markets including the Dow Jones Industrial Average, the S&P 500, the Nasdaq Composite and the Russell 2000 Index all set all-time record highs last week.
This year the VIX, an index measuring implied 30-day volatility in the S&P 500, dropped below 10 points for the first time in a decade, having gradually sunk from a six-month peak of 22.5 points in early November.
While calm markets are generally seen as a positive by the majority of the financial industry, it can present a problem for low-volatility and minimum-variance ETFs which, as discussed in a recent Cerulli report, struggle to deliver on their stated objectives under such conditions. In Europe, these ETFs are offered by providers such as iShares, UBS, PowerShares, SPDR and BNP Paribas.
Investors have begun to take notice, globally withdrawing $600 million from low-volatility ETFs in January, with total assets dropping to $44 billion, according to the latest iShares Landscape Report.
The negative flows were in stark contrast to other smart beta categories, which gathered assets last month. Investors piled approximately $2bn into dividend ETFs, $700m into multi-factor ETFs and $300m into equal-weight ETFs. Dividend ETFs are now by far the most popular smart beta category with $162bn under management.
The market calm is likely not to last however, as the VIX index tends to revert to the mean over time. For investors who want to hedge their bets, ETFs in the low-volatility and minimum-variance category are still worth considering.
The largest minimum-volatility ETF listed in Europe is the iShares Edge MSCI World Minimum Volatility UCITS ETF (LON: MVOL), which holds $1.6bn in assets since launching five years ago. Its total expense ratio (TER) is 0.30%.
The underlying MSCI World Minimum Volatility Index tracks 309 developed companies and “seeks to minimise the market’s peaks and valleys”, according to the factsheet. Healthcare, consumer staples and financials make up the three largest sector exposures at 17.0%, 14.6% and 12.7% respectively. More than 62% of the fund is based in the US, with Japan, Canada and Switzerland-based companies making up most of the remaining exposure.
MVOL is up 12% over one year and 3.9% year to date in USD terms.
If investors had chosen the iShares Core MSCI World UCITS ETF (LON: IWDA), however, they would have seen returns of 22.2% and 4.9% over the same periods. It contains heavier weightings in financial and information technology, more volatile sectors which have performed well in 2016. IWDA is also cheaper at a TER of 0.20%.
The same performance pattern can be seen with the second largest ETF, the iShares Edge S&P Minimum Volatility UCITS ETF (LON: SPMV), also falling behind in terms of returns compared to the iShares Core S&P 500 UCITS ETF (LON: CSPX) over the last year and year to date.
ETFs tracking the VIX have also failed to perform as analysts might have predicted following two incidents last year of rabble-rousing politics, choppy currency exchanges and pledges to majorly reform tax regimes and international trade.
The Lyxor S&P 500 VIX Futures Enhanced Roll UCITS ETF (EN: LVO) has fallen 57% in EUR terms over 12 months and has tanked a whopping 19.2% year to date alone.
But those who took an inverse position – betting on the VIX falling – would have lined their pockets over that period. The strategy to short near-month VIX futures contracts has been boosted from the decline in the prices of the future contracts and “roll yields” from the upward-sloping futures curve.
Although there are several such funds in the US there are none in Europe after one from Lyxor was delisted.