Low Volatility Outperforming Major Indices Over The Past Year

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About: Invesco S&P 500 Low Volatility ETF (SPLV)
by: Josh Ortner
Summary

The S&P 500 Low Volatility Index ETF has been outperforming the overall market index over the past one year.

Low Volatility continues to provide better risk-adjusted returns than the S&P 500.

S&P 500 Low Vol ETF continues to provide lower monthly drawdowns.

At one point last year, I questioned my favorite strategy in the investment world, the S&P 500 Low Volatility Index ETF (SPLV). When treasuries were dropping in price and yields were rising, many market analysts claimed that the end was near for the Low Volatility trade. Something made me want to check on my clients' performances and the overall markets today. As I checked my watchlist, I noticed that SPLV was nearing $51.00/share. After owning and watching this fund since 2011, I quickly took note of that being the highest price ever. As equity markets have recovered well into 2019 from the horrible fourth quarter, the overall indices are not hitting new highs like the SPLV trade. Let's get right into the charts and take a look below at what I'm talking about here.

Chart Data by YCharts

Above we have the three major market index ETFs. Over the past year, we can see that the Nasdaq (QQQ) has returned 7.58%, the Dow Jones Diamonds ETF (DIA) at 3.82%, and the SPDR S&P 500 (SPY) ETF at 3.58%. All somewhat disappointing returns over a year for owning equities. But let's take a look at the SPLV trade.

Chart Data by YCharts

You can see SPLV has returned an impressive 10.15% over the past year - over 600 basis points more than owning the large SPY fund.

What's more impressive to me, however, is the risk-adjusted return it has rewarded clients with.

SPLV vs. SPY 1-Year Risk Analytics

Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown
SPLV $100,000 $106,462 5.95% 12.70% 6.66% -0.18% -6.79%
SPY $100,000 $103,085 2.84% 16.56% 8.01% -4.56% -13.52%

(Source: PortfolioVisualizer.com)

The above table shows how SPLV only had a -6.79% max drawdown on the year, versus the SPY at -13.52%. When finding prudent ways to manage your own wealth or someone other than yours, this surely can foot the bill. The standard deviation of SPLV is also lower at 12.7%, versus the SPY 16.56%. All these ratios look pretty good compared to just owning stocks outright.

Risk Metrics

For those of us who are like me and want to regularly geek out on the risk metrics of an investment, this is for you. Portfoliovisualizer.com does a great job of listing out all these metrics. In the future, I hope to write more regularly updating these risk metrics for followers, as the "proof is in the pudding," so to say.

Metric SPLV SPY

Arithmetic Mean (monthly) 0.55% 0.34%
Arithmetic Mean (annualized) 6.74% 4.17%
Geometric Mean (monthly) 0.48% 0.23%
Geometric Mean (annualized) 5.95% 2.84%
Volatility (monthly) 3.66% 4.78%
Volatility (annualized) 12.70% 16.56%
Downside Deviation (monthly) 2.38% 3.35%
Max. Drawdown -6.79% -13.52%
US Market Correlation 0.90 1.00
Beta(*) 0.67 0.96
Alpha (annualized) 3.87% 0.24%
R2 81.45% 99.40%
Sharpe Ratio 0.37 0.14
Sortino Ratio 0.55 0.19
Treynor Ratio (%) 7.07 2.35
Active Return 3.30% 0.19%
Tracking Error 7.91% 1.45%
Information Ratio 0.42 0.13
Skewness -0.44 -0.51
Excess Kurtosis 0.19 -0.10
Historical Value-at-Risk (5%) -6.79% -8.79%
Analytical Value-at-Risk (5%) -5.48% -7.52%
Conditional Value-at-Risk (5%) N/A N/A
Upside Capture Ratio (%) 73.62 99.16
Downside Capture Ratio (%) 60.78 98.47
Sustainable Withdrawal Rate 97.95% 93.66%

(Source: PortfolioVisualizer.com)

The most interesting ratio for me here is the downside capture ratio. Only 60% of the downside in the S&P 500 is captured by SPLV. This is the most critical element in seeing if a strategy will truly produce alpha for the client. Here you can see SPLV is truly doing that. Beta, which most investors are aware of as well, is coming in at .67 to the overall market. Notice the similarity here to the downside capture ratio? I love it when statistics come together.

SPLV Outperforming By Methodology

When trying to figure out why SPLV performed better this past year, the simple answer was staring me right in the face. As a sector becomes volatile, every quarter the fund reduces its weight to it. One sector that underperformed the rest was Consumer Staples. This sector is usually a Low Vol sector; however, last year, SPLV reduced its weighting to it as it became more volatile. The two largest sectors at around 40% of the whole portfolio were Utilities and Real Estate. Both sectors did well in 2018, as Real Estate (IYR) finished up over 6.15% on the year and Utilities (XLU) finished up over 6.95% as well for the year. As SPLV continues to quarterly re-balance itself, investors should always keep track of the next lowest-volatile sector it rotates into here at Invesco.com.

Summary

As last year ended up being a challenging time for most index investors, SPLV continued to outperform. Year to date, it is slightly underperforming by 80 basis points, but nothing extremely noticeable. When looking at the year ahead, I suspect this to be another volatile year. My crystal ball is broken for sure when it comes to predicting stock movements, but betting on equities being volatile would be a prediction I can stick with. Most home game investors need to manage this volatility risk by owning a fund like SPLV in their portfolio. SPLV and the Low Vol trade can be a way to do this year.

Disclosure: I am/we are long SPLV. 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.

Additional disclosure: Ortner Capital consults clients who own SPLV within the firm. Ortner Capital urges individual investors to consult with a certified professional on their own risks, objectives, and time horizons before investing.