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Multi-Asset Min Volatility For Choppy Times

|Includes: SPDR S&P 500 Trust ETF (SPY)
  • Our Global Min Volatility multi-asset index closed up +1.52% on "Brexit Friday" in GBP terms
  • Risk, return and correlation are always unstable, and that should be reflected in optimisation models
  • Risk-based quant-driven investment strategies offer a lower cost alternative to hedge funds for investors looking to diversify their portfolio returns

A Min Volatility approach

In December 2014, we launched the Elston Strategic Beta Global Min Volatility Index, a multi-asset strategy constructed using a broad range of ETFs (Ticker ESBGMV). The rationale for launching this strategy was to provide a low-cost "liquid alternative" to hedge funds.

Our Global Min Vol Index continues to do what it says on the tin: provide a source of differentiated returns by combining traditional asset classes to minimise portfolio variance whilst keeping potential for returns.

Once certainty about the market, as John Pierpont Morgan famously said, is that it will fluctuate. Since launch, the strategy has coped well with market tantrums from different sources, and will continue to adapt to changing market conditions.

Notably, the index was up +1.52% (in GBP terms) on Brexit Friday.

Fig 1: ESBGMV -1 Month Performance to 24th June 2016

Source: Solactive

Be dynamic, because markets are

The risk, return and correlations between asset classes are not stable, so portfolio construction is sub-optimal if it assumes they are.

Our adaptive approach to portfolio construction embraces the fact that risk, return and correlations are dynamic.

We select a basket of screened ETFs from a broad universe to create a minimum variance portfolio, subject to various turnover and holding constraints, using a clear, systematic rules-based approach.

Asset allocation

At the last rebalancing the allocation to equities within the strategy increased from 31.78% to 37.15%, but it's the risk-return characteristics of the ETFs selected within that overall asset allocation that counts.

Fig 2: ESBGMV Index Composition Weightings, June 2016

Source: Elston Consulting

As at close on Friday 24th June, the annualised 1 year volatility of the strategy s 6.2%, compared to 18.1% for global equities, 8.9% for global bonds and 25.6% for commodities, whilst the Sharpe Ratio is 1.15.

Paradigm shift

The growth in computing power and data availability over the last decade is changing the way portfolios can be managed. This is furthering the role of quantitative investment strategies - whether off the shelf or designed to order - as a source of alternative returns. One key difference is fees, as they require more data and less human resource compared to traditional hedge funds. Furthermore, unlike hedge funds, quant strategies also have the added benefit of being systematic and behaviourally predictable.

Index transparency

By pricing our flagship strategies as indices, we obtain real-time performance transparency. It also make it easier for those wishing to use our strategies for their own funds or ETPs.

The need for diversification and downside protection in choppy markets is not new. What's changing is the tools available to provide this, and the diminishing cost of access.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice. For more information see Photo credit: Euromoney. Chart credits: Elston Consulting, Solactive.