With Uncertainty Ahead, is it Time for Low Vol Strategies?

By STATE STREET GLOBAL ADVISORS – SPDR EMEA ETF Strategy Team

While global growth is expected to slow in 2019, we feel that US equities are still the place to be due to relatively strong earnings and fairly robust economic data.

However, investors should be cognisant of the volatility associated with late economic cycles.
From both a macro and fundamental standpoint, we see reasons why US equities could continue to do well, although there are downside risks to monitor. Given a range of uncertainties — such as the Fed’s rate hike plans, US-China trade disputes, and where in the economic cycle we are — there could be heightened volatility ahead. In light of this backdrop, our strategists favour defensive US equities to help investors ‘smooth’ their potentially bumpy investment journey.

Over the last 12 months, we saw a large return gap between the S&P 500 Low Volatility Index and S&P 500 Minimum Volatility Index. Both strategies seek to reduce volatility through targeting less volatile stocks. However, the approaches are quite different, which has given rise to drastically divergent return and risk profiles.

• The S&P 500 Low Volatility Index beat the S&P 500 Minimum Volatility Index by nearly 5% in 2018. Both S&P 500 and S&P 500 Minimum Volatility indices had negative absolute performance, whereas the S&P 500 Low Volatility Index had strong positive performance on both an absolute and risk-adjusted basis.1

• More regular rebalancing and the absence of relative caps may have helped the performance of the S&P 500 Low Volatility Index in Q4. In Q4 last year, the S&P 500 dropped -13.65% while Low Volatility outperformed Minimum Volatility by +6.54%.2 The S&P 500 Low Volatility Index rebalances much more frequently than the S&P 500 Minimum Volatility Index. Moreover, unlike its Minimum Volatility counterpart, the absence of any relative caps in the S&P 500 Low Volatility Index means that the strategy has more flexibility to move to the most defensive stocks in volatile environments.

• The S&P 500 Low Volatility Index had lower beta3 than the S&P 500 Minimum Volatility Index. The beta of the S&P 500 Low Volatility Index was 0.58, whereas the beta of the S&P 500 Minimum Volatility Index was higher at 0.73.

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