Late summer has not been fruitful for the low volatility factor. From July 6 to Sept. 9, the S&P 500 Low Volatility Index has fallen by 4.67%, while the S&P 500 Index gained 1.70%.1 This is in sharp contrast to the second quarter, when the low volatility index returned 6.75%, and the broad-market index returned 2.46%.1 Naturally, some investors are wondering what’s behind the shift.
Looking at market conditions during late summer, I see three headwinds that were working against the low volatility factor:
- Interest rates rose. The 10-year Treasury yield rose from 1.31% on July 6 to 1.67% on Sept. 9.1
- Volatility was relatively flat. The CBOE Volatility Index (the VIX) was 14.96 on July 6 and was 12.51 on Sept. 8. before finishing at 17.5 on Sept. 9.1
- The S&P 500 Index rallied. While the index gave back much of its earlier gains on Sept. 9, it had rallied for most of July and August.
When has low volatility outperformed?
The low volatility factor has tended to shine when interest rates are flat to lower, stock prices are falling and volatility is rising. We can see this in the table below, which examines the performance of the S&P 500 Low Volatility Index during extreme moves in the S&P 500 Index, the VIX and 10-year Treasury yields from May 2011 through August 2016. In that time frame, there were 64 months of returns. The table examines low volatility performance during the most extreme months (the top 25%) in terms of the largest increases and decreases in each index.
Bloomberg, L.P., Sept. 14, 2016. Index returns do not represent Invesco products. The total time period analyzed was 64 months, from May 2011 through August 2016. The most extreme market movements represent the top 25% of that time period (16 months) in terms of monthly percentage movements in the index and direction noted. For example, the most extreme VIX increases are the 16 months (out of the 64 total) with the largest monthly percentage increases in the VIX. Past performance is no guarantee of future results.
Examining low volatility results
- By volatility. During the 16 months when the VIX had its largest percentage increases, the S&P 500 Low Volatility Index outperformed the S&P 500 Index 62.5% of the time, with an excess return of 51 basis points (bps). In contrast, during the 16 months when the VIX had its largest percentage drops, the low volatility index outperformed the broad market just 25% of the time, with an average lag of 107 bps.
- By rates. During the 16 months when the 10-year Treasury yield had its largest percentage increases, the S&P 500 Low Volatility Index outperformed the S&P 500 Index just 25% of the time, trailing by an average of 169 bps. During the top months of yield declines, the low volatility index outperformed the broad market 87.5% of the time, with an average excess return of 241 bps.
- By market performance. During the 16 months when the S&P 500 Index had its largest declines, the S&P 500 Low Volatility Index outperformed 87.5% of the time, with an average excess return of 176 bps. In contrast, during months when the S&P 500 Index gained the most, the low volatility index outperformed 12.5% of the time, with an average underperformance of 156 bps.
Bottom line: Low volatility is performing as expected
When you look at the market conditions experienced in late summer, it’s no surprise that low volatility shares underperformed the broad market. This is by design. However, it’s important to remember that the low volatility factor does occasionally outperform in up markets and occasionally lags in down markets. And while higher rates and a lower VIX have been headwinds for low volatility, the results are not absolute. There are exceptions. Understanding market trends and the potential for exceptions can help investors set proper expectations for low volatility performance.
Learn more about the PowerShares S&P 500 Low Volatility Portfolio (SPLV).
1 Source: Bloomberg, L.P. Sept. 14, 2016. Past performance is no guarantee of future results.
The S&P 500® Low Volatility Index consists of the 100 stocks from the S&P 500® Index with the lowest realized volatility over the past 12 months. An investment cannot be made into an index.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
Excess return refers to excess return generated by one index, strategy or investment factor over another.
Yield is the income return on an investment.
A basis point is one hundredth of a percentage point.
Volatility measures the standard deviation from a mean of historical prices of a security or portfolio over time.
Standard deviation measures a portfolio’s range of total returns and identifies the spread of a portfolio’s short-term fluctuations.
Factor investing is investment strategy in which securities are chosen based on attributes that have been associated with higher returns.
Treasury securities are backed by the full faith and credit of the US government as to the timely payment of principal and interest.
There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund’s return may not match the return of the underlying index. The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the fund.
Investments focused in a particular sector, such as industrials, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.
The fund is non-diversified and may experience greater volatility than a more diversified investment.
There is no assurance that the fund will provide low volatility.
Shares are not individually redeemable and owners of the Shares may acquire those Shares from the fund and tender those Shares for redemption to the fund in Creation Unit aggregations only, typically consisting of 50,000, 75,000, 100,000 or 200,000 Shares.
Nick Kalivas
Senior Equity Product Strategist
PowerShares by Invesco
Nick Kalivas is a Senior Equity Product Strategist representing the PowerShares family of exchange-traded funds (ETFs). In this role, Nick works on researching, developing product-specific strategies and creating thought leadership to position and promote the smart beta* equity line up.
Prior to joining Invesco PowerShares, Mr. Kalivas spent the majority of his career in the futures industry, delivering research, strategy and market intelligence to institutional and high net worth clients centered in the equity and interest rate markets. He was a featured contributor for the Chicago Mercantile Exchange, and provided research services to a New York-based global macro commodity trading advisor where he supplied insight on equities, fixed income, foreign exchange and commodities. Nick has been quoted in the Wall Street Journal, Financial Times, Reuters, New York Times and by the Associated Press, and has made numerous appearances on CNBC and Bloomberg.
Nick has a BBA in accounting and finance from the University of Wisconsin – Madison and an MBA from the University of Chicago Booth School of Business with concentrations in economics, finance, and statistics. He holds the Series 7 and Series 63 registrations.
*Beta is a measure of risk representing how a security is expected to respond to general market movements. Smart beta represents an alternative and selection index based methodology that may outperform a benchmark or reduce portfolio risk, or both.