And there are more risks: so much money has been flowing into low-volatility stocks in recent years that not only performance has been rising, so have valuations of these stocks. Active managers can address this issue by incorporating other factors in their stock selection model.
“As an example, Unigestion (which runs the Uni-Global Equities series) is analysing valuation both at the security and sector level and can implement constraints in its optimisation model if it identifies pockets of high valuation”, the analysts write.
Liquidity shortages are also a potential issue. Considering the large capital flows into a limited bucket of stocks, “there is a valid concern [managers] could run into liquidity problems.”
Active vs passive
While active low-vol managers have more possibilities to address the unintended consequences of investing in low-volatility stocks than passive solutions, that of course comes with a cost: the fees of the active low-vol equity funds in the graph below start at 1.18% (Robeco), while the total expense ratio of the iShares Minimum Volatility ETF is only 0.25%.
But active low-vol funds have held up pretty well against passive alternatives regardless, with the Invesco Pan European Structured Equity fund even outperforming over the past four years.
