In recent years, here on The Value Perspective, we have written a number of pieces on the potential shortcomings of funds that invest in supposedly low-volatility assets – effectively, that they may not offer quite the returns, the peace of mind or indeed the low volatility their investors might be hoping for – and yet our warnings would appear to have fallen on a few deaf ears.
Quite a few deaf ears, if we are honest. According to fund data provider Morningstar, the number of low-volatility funds available in Europe doubled to just shy of 90 over the five years to the end of 2016.
In that time, the 63 open-ended funds and 26 exchange-traded funds (ETFs) in the sector saw net inflows of €27bn (£23.6bn) so that, by 31 December, total assets under management stood at €40bn.
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Some 15% (€6bn) of this was in the ETFs and we mention that specifically because a new piece of research from our friends at Empirical Research Partners has some good news for low-volatility ETF investors – and also some bad news.
Good news for low volatility ETFs…
The good news is that since 2011, when money really started flowing into the sector, the funds themselves have outperformed the market by some 30 basis points.
…and the bad news
The bad news, however, is that the majority of investors have not seen that outperformance. Empirical use the ‘money-weighted return’ to calculate performance.
This factors in the size and timing of the investments made, which shows the returns most people actually made.
According to Empirical, the money-weighted return over the last six years has been an actual underperformance of around 150 basis points.
A significant number of investors, in other words, managed to pick the wrong time to direct money towards the sector – notably the second half of 2016, when low-volatility assets had a difficult time.
Investors follow good performance
As often happens when a particular kind of investment has done well for a number of years, it becomes an increasingly ‘crowded trade’ – the polar opposite of what, as contrarians, value investors are seeking out.
And largely because of investors chasing past performance – the timing of the wider market can end up being pretty poor.
On a similar note, Empirical flags up a recent paper that set out to calculate the difference between the returns an investor would have seen if they had bought and then held the ETF that tracks the main US index, the S&P 500, between 2007 and 2015 and the actual returns investors have made from that investment.
According to the paper, the gap was around 25 basis points per year.
At first sight, one quarter of one percentage point does not sound like a huge amount of drag in the context of the sort of returns investors would be targeting from the S&P 500.
And yet, as Empirical points out, investors have for some years now been going to great pains to force down the cost of their investments – and one of the great reasons for moving to passive vehicles is to pay as little as possible in this regard.
Investment timeframe matters
So while that is a perfectly sensible thing to do in theory, it becomes less so in practice if – in this instance – the timeframe over which you hold your low-cost investment is so short, the drag you see on the index you are tracking is three times the cost of your ETF.
While what you pay for an investment obviously has a bearing on the return you see at the end, so does how you behave with that investment – which is why, here on The Value Perspective, we set out to hold assets for a minimum of three to five years.