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Summary

  • Creating an Ultra-Low Volatility Index involves trade-offs.
  • I have some provisional ideas, but no definitive solutions yet.
  • Our provisional Ultra-Low Volatility Index has reached an all time high.

Originally, we explored ideas about how to create an Ultra-Low Volatility Index. We zeroed in on some simple rules. Admittedly, the results are provisional. I need more time, data, and real-world performance data. However, the provisional results are not bad.

Here are the provisional Ultra-Low Volatility Index strategy's rules.

I. Go Long SPLV (NYSPLV) with 80% of the dollar value of the portfolio.

II. Go Long TMF (NYTMF) with 20% of the dollar value of the portfolio.

III. Rebalance annually to maintain the 80%/20% dollar value split between the positions.

Here are the results in a linear scale:

(click to enlarge)

I am intrigued by the possibility of a higher compound annual growth rate, combined with a lower maximum drawdown, and a higher Sharpe ratio than the S&P 500 ETF (NYSPY).

As I pointed out in the first article in this series, my logic for exploring this potential strategy is that a leveraged ETF, because of the leverage inherent in the instrument, negates the need for even more dangerous portfolio margin debt, which is often inherent in risk parity strategies. And to avoid open-ended tail risk, and I am eating convexity by going long TMF as opposed to capturing the convexity inherent in shorting TMV (NYTMV).

In addition, my original thought in using the S&P 500 Low Volatility ETF was to minimize the need for the bond allocation, which could be a serious drag in a rising interest rate environment. My reasoning is that low volatility stocks need less of a bond hedge (which may not be a hedge at all in certain interest rate environments).

Overall, while there is significant outperformance in a very short time period, there is a clear pattern of the strategy outperforming in tough years for the S&P 500 and lagging in strong up years for the S&P 500.

I am intrigued by these admittedly provisional results, and will keep a watchful eye on our provisional Ultra-Low Volatility Index going forward.

This provisional index is not extremely original, like some of our other work, but like an A-10 Warthog, this strategy-index may prove to be ugly, but highly durable. We need more data to make any firm conclusions.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in TMF over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Ideas For An Ultra-Low Volatility Index Part II