Active assault on low-volatility trackers

October 21, 2013 12:26 pm

Active assault on low-volatility trackers

By Jackie Noblett

Several firms are looking to take a slice of the growth of assets that have flooded into low-volatility index exchange traded funds by rolling out actively managed funds. While prevalent among institutions for years, these retail funds are increasingly going head-to-head with the popular index-based ETFs in the market. Fund executives and analysts say the decision to go active versus passive is a matter of philosophy and intent rather than of one being better than the other.iShares, Invesco PowerShares and State Street have all sought to launch products that screen well-known indices for the lowest-volatility stocks, albeit with different screening methodologies, analysts note. Low-volatility ETFs from those firms have attracted about $4.3bn in inflows year-to-date, according to IndexUniverse data.

State Street Global Advisors is the latest to look at active management for low volatility, registering to launch the SPDR SSgA Emerging Markets Minimum Volatility ETF. The ETF takes an active approach to an asset class covered by the iShares MSCI Emerging Markets Minimum Volatility ETF and the PowerShares Emerging Markets Low Volatility Portfolio.

Vanguard is also looking to use active management to enter the low-volatility investing space. The firm registered to launch a Global Minimum Volatility Fund but did not propose an ETF version.

Invesco remade two mutual funds into products that explicitly pursue a low-volatility theme in July. They joined Fidelity, Nationwide and Calvert Investments as new managed-volatility funds this year.

The proliferation of products executing similar strategies raises the question for investors and advisers of what they are looking for in a low-volatility investment.

“It comes down to the question of active versus passive,” says Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ.

“In the ETF space, you have three ETFs out there that are extremely different in their underlying holdings because some enable sector bias and some constrain sector bias…. On the mutual fund side, the output is going to be different depending on what the broad universe of stocks is and what are management’s discretion and goals,” he adds.

Invesco is among the few firms to offer retail investors low-volatility products in both active and passive formats. Its index-based PowerShares line of ETFs has more than $5bn in assets under management globally in addition to the recently launched mutual funds.

The firm likes to look at the products as achieving slightly different goals.

For example, the active mutual fund is looking for low-volatility stocks while using its stock selection capabilities to seek out above-market returns, says Donna Wilson, managing director for portfolio management in Invesco’s quantitative strategies group. This could give the active fund different sector weights — and therefore different return profiles — than an index-based approach, she adds.

The PowerShares index ETF series, which screens the least volatile stocks from benchmark indices like the S&P 500, was designed to give investors easy, liquid access to the low-volatility investing strategy, says Dan Draper, managing director of global ETFs at PowerShares.

Generally the firm sees more tactical investors drawn to the ETF and its liquidity, while a buyer seeking a long-term, strategic low-vol investment may look at the mutual fund, officials say.

Yet that is not universally the case among investors, according to some industry insiders.

Russell Indexes, which works with SSgA on the manager’s SPDR Russell 2000 Low Volatility and SPDR Russell 1000 Low Volatility Portfolio index ETFs, has seen and heard investors using index-based low-vol ETFs as either replacements or supplements to core holdings, says David Koenig, investment strategist at Russell.

Mr Koenig says Russell’s low-volatility methodology allows for a more diversified holding compared to other low-volatility indices because it screens for concentrations in traditionally less volatile asset classes like utilities and consumer staples. He also highlights research that indicates that over long stretches of time, low-volatility factors tend to outperform market cap–weighted indices.

Yet for some managers, the decision whether to go passive or active on low volatility is less about performance and more about philosophy.

Vanguard declined to comment about its low-volatility fund filing. In general, the firm believes that many of the so-called “smart beta” indices developed recently are passive constructions of active strategies, says Joel Dickson, senior investment strategist and a principal in Vanguard’s investment strategy group.

“We actually think there is a discussion to be had broadly about calling a spade a spade, not having an active strategy cloaked in an index Halloween costume,” he adds.

For investors, the choice between active funds and passive funds will ultimately come down to the desire for potential alpha generation versus the desire for lower-cost and more transparent portfolios, S&P Capital IQ’s Mr Rosenbluth says.