Soaring market volatility as the S&P 500 has fallen 11% off highs reached in mid-September has caused investors to rush to low volatility stocks—and they have been well rewarded. Low volatility funds, although still experiencing declines, are holding up much better. The iShares Edge MSCI Min Vol USA ETF (USMV), which applies a set of risk-control constraints in picking stocks with the smallest average moves, has fallen just 4.5% over the same period, while the purer low-volatility strategy of a fund like the Invesco S&P 500 Low Volatility ETF (SPLV), which has no weight constraints, has fallen just 2.7%.
These low-volatility funds are getting a boost form investors flocking to safety amid much uncertainty. “If you think about what’s happening now across the board, we are surrounded by uncertainties, and certainty is becoming more attractive to everyone in the market,” Brian Cho, Chiron Investment Management’s head of quantitative research, explained to Barron’s late last week.
Protection in an Uncertain Environment
While volatility spiked earlier in the year on concerns of rising interest rates and an overheating economy, the escalating trade dispute with China, fears that the Fed has gone too far with rate hikes, gridlock in Congress, more oil sanctions, and the slower growth and weaker inflation that all these factors could engender, have only served to inflame even more uncertainty and reignite the market volatility. In such an environment, defensive sectors like utilities and consumer staples tend to offer investors the best protection due to the non-cyclical nature of their underlying business.
Duke Energy Corp. (DUK) and WEC Energy Group Inc. (WEC), two utility-sector stocks, are still sitting near their all-time highs. On the year, Duke is up 7.9% while WEC is up 11.9%. Procter & Gamble Co. (PG) and Coca-Cola Co. (KO), from the consumer-staples sector, are also faring well. Procter & Gamble is currently at an all-time closing high and up 5.2% year to date, while Coca-Cola is down about 2% from an all-time high reached last month and up 7.5% for the year.
It is worth noting that while low volatility stocks have been outperforming in the recent bout of uncertainty, that is not always the case as illustrated by the volatility earlier in the year that saw low-volatility funds perform only marginally better than the overall market. Rising interest rates, for one, are a bane for utility stocks, which end up having to compete with bonds and whose companies face higher borrowing costs. But if the increased uncertainty from factors such as the China-U.S. trade dispute continues to weigh down the overall market, the defensive characteristics of low-volatility stocks may start to look increasingly attractive.