In Europe alone, low-vol funds have seen €27bn of net inflows since 2012, according to Morningstar. This popularity has led to an explosion of funds in the category. At the end of 2016, there were 89 low-vol equity funds (63 actively managed funds and 26 ETFs) for sale in Europe, almost three times the number of available funds six years earlier.
And it’s of little surprise that low-volatility funds have been in such great demand: they haven’t only been less volatile than the index, but have combined that with long-term outperformance (see graph below).
Though these funds are called ‘low-volatility funds’ in popular speech, most of these are actually ‘minimum volatility funds’. Such funds, be they passive or active, do not just select the least volatile stocks in a certain index, as low volatility indices do.
They also take correlation and sector effects into account, producing an index that delivers even lower volatility. Simple low-volatility indexes, for example, are often skewed towards interest rate sensitive stocks, “resulting in greater under- and overperformance in rising and falling interest rates environments”, Morningstar’s analysts note in their report.
Will outperformance continue?
The question is of course whether this outperformance of minimum volatility will persist. The experience of the past 12 months showed that this shouldn’t be taken for granted. The funds in the category retain a bias towards quality stocks, which tend to underperform in a rising rate environment and during strong bull markets.
Some active funds, such as the Robeco conservative equity range, try to overcome this by incorporating a momentum factor, improving performance on the upside.
