ACWV: Outperformance From A Global Low Volatility Fund

| About: iShares Edge (ACWV)

Summary

Low volatility investing reduces risk and outperforms over long-term time periods.

Diversifying portfolios to include international stocks also reduces risk and outperforms over long-term time periods.

The combination of both low volatility and diversified investing may significantly reduce risk and increase performance over long-time periods.

ACWV is a global low volatility ETF that has outperformed its global benchmark.

ACWV is a suitable core fund for a diversified low-volatility portfolio.

Introduction

There is a great deal of academic research showing that low volatility funds outperform over long periods of time despite the risk vs return tradeoff that suggests risk and reward are positively correlated. For example, Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly (Baker, Bradley, and Wurgler, 2011) shows that low volatility portfolios provided high average returns and small drawdowns over the 1968-2008 time period. In Low-Volatility Investing (Hsu and Li, 2013) show that low volatility portfolios outperform large-cap core equity indexes over multiple time periods while demonstrating lower risk and higher Sharpe ratios. Baker and Haugen (2012) also show that low risk stocks consistently outperformed in 33 different markets within an international universe in their paper titled Low Risk Stocks Outperform within All Observable Markets of the World. In my (2016) article Why Low Volatility Funds Outperform, I have shown that the outperformance of low volatility funds is primarily attributed to outperformance in years with negative market returns.

There is also research showing that diversifying portfolios to include international stocks increases long-term returns and reduces volatility. Because the majority of public companies occur outside the United States, a U.S.-only portfolio is an active choice to not invest in the total market. According to Fidelity, during the period of 1950-2014, the addition of 30% International developed stocks to a portfolio of U.S. stocks increased annualized returns and Sharpe Ratio, and decreased the standard deviation (volatility). On the other hand, it appears that there is an increasing trend of correlation between U.S. and international markets as a result of globalization. If this trend continues, the diversification advantages of investing in foreign stocks may be decreased or disappear for tactical short-term investors. However, diversification may continue to provide benefits for strategic long-term investors.

There are several ways of combining the benefits of low volatility investing and international diversification. Investors can purchase a combination of U.S., International developed, and emerging market low volatility funds. Investors may also purchase global low volatility funds. This article focuses on the iShares Edge MSCI Min Vol Global ETF (NYSEARCA:ACWV), which is a global low volatility fund.

All material in this article is based on information available on August 1, 2016.

Description

ACWV tracks the MSCI ACWI Minimum Volatility (NYSEARCA:USD) Index. The index considers covariance in determining the lowest portfolio variance across 23 developed and 23 emerging market countries. The Barra Optimizer is used to optimize low volatility within a set of constraints. These constraints include ensuring replicability and investability, index turnover limits, minimum and maximum constituents, currency optimization, and sector and/or country weights relative to the parent index. As a result, the index may not include all 46 countries. The index is rebalanced semi-annually in May and November.

Valuation and Yield

As shown in the original table below, the ACWV portfolio has a significantly higher valuation compared to its MSCI ACWI benchmark (NASDAQ:ACWI). I have also included the S&P 500 (NYSEARCA:SPY) for comparison. Inclusion of international stocks significantly reduces the valuation, whereas low volatility increases it.

ACWV

ACWI

SPY

Price/Trailing Earnings

21.41

16.91

19.35

Price/Book

2.66

1.96

2.71

Price/Sales

1.83

1.4

1.89

Price/Cash Flow

11.88

9.67

12.09

30-day SEC Yield

2.25

2.12

2.01

Source

Fidelity

Fidelity

Fidelity

Click to enlarge

Portfolio Composition

According to Morningstar, ACWV currently includes 351 stocks with ~82% of its allocation to giant/large-cap stocks, and ~18% to mid-cap stocks. In contrast, ACWI includes 1291 stocks with ~90% of its allocation to giant/large-cap stocks, and ~10% to mid-cap stocks. Annual portfolio turnover is 22% for ACVW as compared to 6% for ACWI.

According to Fidelity, ACWV includes stocks from 28 countries with a regional exposure of ~62% North America, ~26% Asia, ~9% Europe, ~2% Middle East, and ~1% Latin America. In contrast, ACWI includes stocks from 49 countries with a regional exposure of ~56% North America, ~22% Europe, ~19% Asia, ~1% Latin America, ~1% Africa, and ~0.5% Middle East.

The following original table compares portfolio sector composition of ACWV versus ACWI. The sector weightings of ACWV differ significantly from both ACWI and SPY, whereas ACWI and SPY are similar. ACWV has a low allocation to technology and energy, as do most low volatility funds.

ACWV

ACWI

SPY

Cyclical

Basic Materials

3.54

5.16

2.79

Consumer Cyclical

7.72

11.09

11.10

Financial Services

9.76

16.76

12.82

Real Estate

7.17

3.24

2.60

Sensitive

Communication Services

10.57

5.10

4.32

Energy

1.51

6.65

6.95

Industrials

12.18

10.71

10.96

Technology

5.71

14.80

18.47

Defensive

Consumer Defensive

16.31

10.47

10.24

Healthcare

17.12

12.57

15.32

Utilities

8.42

3.47

3.44

Source

Morningstar

Morningstar

Morningstar

Click to enlarge

Performance

ACWV has annual total return (capital gains plus dividends) data for 2012-current, and index backtest data available to 2002. ACWI has annual total return data for 2009-current, and index backtest data available to 2002. The original chart below shows relative annual performance of ACWV and ACWI with a starting value of $100,000 beginning at the end of 2001. The index annual backtest data (corrected for fees) was used in years prior to the initiation of the ETFs, and Morningstar data was used for years after ETF initiation.

The original graph below shows the annualized performance of ACWV, ACWI, and SPY over the time period of 2002-current with a starting value of $100,000. ACWV significantly outperformed both ACWI and SPY, whereas the performance of ACWI and SPY was similar. The comparison of ACWI vs SPY shows that inclusion of international stocks was beneficial to performance prior to 2008, but detracted from performance starting in 2008, and especially after 2012. Please keep in mind that the starting date can have a significant impact on these kinds of analyses; starting in 2009, for instance, would lead to a much different conclusion. I generally try to analyze the maximum time period for which I have data. In addition, the annualized data does not show the within-year variation in performance.

Click to enlarge

Risk

Over the last 3 years, ACWV has a significantly different risk profile compared to ACWI. The original table below compares the standard deviation, upside capture ratio, and downside capture ratio of ACWV and ACWI as compared to the MSCI ACWI Ex USA NR USD benchmark. ACWV has a lower standard deviation, lower upside capture ratio, and much lower downside capture ratio compared to ACWI. This is consistent with the performance of low volatility funds. I have also shown the standard deviation of SPY, which is similar to that of ACWI, for comparison.

3-Year:

ACWV

ACWI

SPY

standard deviation

8.58

11.77

11.08

Upside Capture Ratio

71.76

99.67

NA

Downside Capture Ratio

19.31

73.08

NA

Source

Morningstar

Morningstar

Morningstar

Click to enlarge

Fund Costs

ACWV net fund expenses are 0.2% as compared to 0.33% for ACWI and 0.09% for SPLV. This is an unusual case where a low volatility fund is less expensive than its non-low volatility benchmark. ACWV can be purchased commission free (NYSE:CF) at Fidelity.

Alternatives

There is no other global low volatility ETF other than ACWV. There are global multifactor ETFs that include low volatility as one of their factors, such as the JP Morgan Diversified Return Global Equity ETF (NYSEARCA:JPGE). There are also a few global equity low volatility mutual funds such as the Vanguard Global Minimum Volatility fund (MUTF:VMVFX) and the BMO Global Low Volatility Equity fund (MUTF:BAEGX). In addition, you can invest individually in U.S., International Developed, and Emerging Market low volatility ETFs from Powershares (SPLV, IDLV, EELV) or iShares (USMV, EFAV, EEMV).

Conclusion

Because of its strong long-term performance, low risk, and global portfolio, I utilize ACWV as a core holding in my portfolio. Because I target an overall 20-30% foreign stock component for my portfolio, I balance ACWV with other U.S. stock funds.

Disclosure: I am/we are long ACWV, SPLV, IDLV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.