Low Volatility ETF PK Minimal Volatility ETF

There's a well-known saying in the financial world - "high risk, high return" - that the only way to get higher risk is to take higher Returns, which is also perfectly justified by the classic CAPM capital asset pricing model. However, theory has its own plan and reality has another. Today we're going to talk about volatility ETFs in SmartBeta.

There are two types of ETFs in the U.S. equity ETF market that aim to reduce volatility.

1) Low Volatility ETFs, as represented by the Invesco S&P 500 Low Volatility ETF (SPLV).

2) The Minimum Volatility (Min Vol) ETF as represented by the iShares Edge MSCI Min Vol USA ETF (USMV).

Both were launched in 2011, just six months apart, and since then they have been on a long journey of falling in love with each other. They look similar at first glance, but are actually based on completely different theoretical constructs. As of last week, SPLV had about $8 billion in assets and USMV more than $35 billion, with the former returning year-to-date about The USMV also earned a negative 5% return last year, while the latter returned more than positive 5%, with a 15% difference between the two over five years. The title of "ETF of the Year" has been a big hit, and the winner seems to be a foregone conclusion.

Low Volatility ETFs

The Low Volatitliy ETF is an investment in stocks that have lower stock price volatility.SPLV picks the S&P The 100 stocks in the 500 with the lowest volatility over the past year, and the lowest volatility stocks are given the highest weighting. The rationale behind this is the "low volatility effect" and because it goes against the common belief that to achieve high returns, one must bear A common knowledge of high risk, also known as "low volatility anomaly", or Volatility Anomaly.

Low volatility anomaly is the academic term for the fact that stocks with low volatility exhibit a better risk-adjusted return on capital (Risk-adjusted return). Adjusted Return, a common metric is the Sharp Ratio. Intuitively, the difference between getting a 20% return taking on 30% volatility and getting a 20% return but only taking on 10% volatility. SPLV has indeed historically fallen less than the S&P 500 in almost every significant move.

So why is this an anomaly? There are several explanations.

(1) Benchmark limits: actively managed fund managers are trying to outperform the market based on the fundamental assumption of high risk and high return, or CAPM is at least partially established and will go after those high volatility stocks. This will lead to overvaluation of those stocks and consequently undervaluation of low volatility stocks.

2) Gambling psychology: the speculative psychology of investors on the stock market, buying stocks not to invest, but want to "win the lottery", buying stocks actually in gambling, but also lead to high volatility of the stock price abnormally high, low volatility of the stock is undervalued.

3) Overconfidence: people often overestimate their own abilities and the accuracy of private information, especially in professions with some expertise Obviously, it's also a classic theory of behavioral finance. Like how fund managers always think they can outperform the market.

Minimum Volatility Class ETFs

The theoretical cornerstone of the Min Vol ETF is the mean-variance and efficient frontier theory of Markowitz, the founder of modern finance theory. . The broad outline is as follows.

1) Consider the change in the price of a security as a random variable and measure the return by the mean of its expected return and the risk by its variance, hence Markowitz theory is also known as mean-variance analysis.

2) Taking the ratio between the various securities in the portfolio as a variable, the problem of finding the minimum risk of a portfolio with a certain return is taken as It comes down to a quadratic planning problem under a linear constraint. Investment decisions can then be made based on the investor's preferences, theoretically the no-difference curve.

The effective frontier is the portfolio with the greatest return, given the risk, and the portfolio with the least risk, given the return.

From this theory, we can know two basic truths in portfolio construction:

1) A good portfolio is not simply the sum of individual good securities;

2) A portfolio has a risk diversification function: the less correlated the performance of the securities that make up the portfolio, the more diversified its risk is.

In short, the USMV is a minimum variance portfolio constructed using this theory. The process is as follows.

1) Calculate the volatility of each stock.

2) Analysis of correlations between stocks, between sectors, and between countries.

3) Limit exposure to sectors and countries to plus or minus 5 per cent of their parent index.

4) Optimize the combination according to the limits to achieve the minimum volatility.

Sector distribution

This year, due to the impact of the epidemic and the global recession, the industry divide has become very significant. Instead, the traditionally more defensive industries have been more severely unemployed and impacted, and the technology industry, which is generally considered to be more aggressive, has everyone All can work from home, but are not so affected. That's why companies like SPLV, which just picks the companies with the lowest volatility over the past year, often find themselves standing on the wrong side of the One side. A comparison of SPLV's plate distribution before and after May's rebalancing shows that its plate shifts can be very aggressive. pre-May With nearly 60 per cent of assets invested in utilities, real estate and financials, the largest investments became medical and durable goods after the May adjustment. consumption.

In contrast, USMV, because it does not simply select the lowest volatility stocks from the bottom up as SPLV does, but by optimizing the portfolio way, and limits the sector's weighting to not deviate too much from the parent index. Its technology-related exposures are almost always the highest.

Both of these types of volatility ETFs are not limited to the U.S., but also apply to other countries and regions, and there are related ETFs in the market, so look for them if you're interested.