A headline on ETF Trends recently referred to low, or minimum, volatility funds as “The New Black.” While it’s always nice to be in vogue, the headline picked up on a trend that we are seeing when it comes to flows of exchange traded products (ETPs).
Take a look at this chart:
So far in February, global ETP industry inflows remain positive but have moderated from the record levels we saw in January. However, we’re seeing strong investor interest in minimum volatility – or min. vol. — ETPs. The concept behind these funds is that they track indexes that seek to capture the broad equity market exposure of a particular market segment – like emerging markets or global stocks — with a reduced amount of volatility. As a category, min vol indexes are designed to deliver lower volatility than traditional market cap weighted indexes by tracking low beta stocks. They seek to provide risk-adjusted returns and protect against some of the downside risks that occur in the market from time to time.
This year through February 19, as the chart shows, min vol funds have attracted average monthly flows of close to $900 million. That is more than double the average monthly flows we saw in 2012 and far above 2011’s average monthly flows of less than $100 million,
Part of that surge in flows is attributable to the fact that ETF providers are offering more of these funds. For instance, at iShares, we introduced our suite of minimum volatility products (EEMV, EFAV, USMV, and ACWV) in late 2011.
In aggregate, there are now 32 ETPs available globally based upon minimum volatility indexes, which together hold $8.2 billion in assets. It’s important to note, though, that there are considerable differences in exposures offered by these ETFs based on the methodology of the indexes they track. Some indexes screen out the most volatile stocks, while others take a more dynamic approach to screening for low beta stocks to track. For instance, the iShares min vol suite of ETFs seeks to track the MSCI family of minimum volatility indexes. To build its indexes, MSCI assesses an individual stock’s volatility compared with the broader market, and it also looks at that stock’s correlation to other stocks in the index.
Today, we’re seeing investors use min vol ETPs as a means to gain access to the equity markets while maintaining some downside protection. In January, ETP flows were decidedly risk on in nature, with equities accounting for 94% of flows. With min vol ETPs, investors can dip back into the market while potentially mitigating their risk exposure. But it’s not just the U.S. equity market we’re talking about here. Min vol funds also give investors access to global markets. For instance, the iShares MSCI Emerging Markets Minimum Volatility ETF – EEMV – invests in some of the least volatile stocks in emerging markets. It has attracted $463 million in new flows year-to-date, while USMV has attracted $651 million in flows and the PowerShares S&P 500 Low Volatility Fund has attracted $101 million.
With investors now watching the U.S. budget sequester – automatic federal government spending cuts set to take effect on March 1 – Russ Koesterich expects market volatility to rise. The flows are showing that ETP investors are using min vol funds to stay invested in the equity markets even if political headwinds cause some short-term bumps.
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. The Funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.