Minimum Volatility May Be Smart, But Only Over the Longer Term
July 28, 2020 — London
Funds driven by low beta stocks have flattered to deceive during the COVID-19 pandemic
Minimum volatility products have outperformed broader market indices over a longer horizon, but fell short during the COVID-19 pandemic-fueled downturn as volatility reached all-time highs, according to the July 2020 issue of The Cerulli Edge―European Monthly Product Trends.
In March 2020, the financial markets responded with panic to the coronavirus outbreak, notes Cerulli Associates. The VIX, an index that measures the level of volatility in stock markets by looking at the options market, rose to 82.69 during the month as investors tried to assess the likely fallout from the global health crisis.
Fabrizio Zumbo, associate director, European asset management research at Cerulli, explains that during periods of volatility, investors typically turn to products designed to protect against—or even benefit from—rising tension in risk assets. Minimum or low volatility products—part of the smart beta family—dominate the European volatility fund landscape. As of May 31, 2020, €24.4 billion (US$27.4 billion) was sitting within 78 funds dedicated to these factors.
The MSCI’s minimum volatility index has steadily outperformed its higher-beta parent over the past two decades. However, it has actually underperformed so far in 2020, registering a 9.2% loss compared to the broader market’s 7.7% fall. Broadridge figures shows that investors withdrew €413 million from minimum volatility funds during the month, with further redemptions in April (€30 million) and May (€75 million). This is in contrast to 2019, when such funds saw record inflows of €6.6 billion.
European regulators have historically been protective of retail investors. This contrasts with the U.S., where the retail market is more developed and where options trading (including bets on the VIX) is more commonplace.
“Cerulli does not expect options trading to increase in popularity in Europe in the near term. We expect investors to continue to seek more traditional safe havens such as gold,” says Zumbo. “With the VIX still sitting at an elevated level, the market may be wary of a second wave of infections and its likely impact on business activity. The demand for defensive strategies will not disappear overnight.”
- Markets performed well in May as investors remained quietly optimistic that economies would slowly reopen around the world, despite the continuing COVID-19 pandemic. €175 billion (US$200 billion) was added to European long-term mutual funds in the month, largely driven by flows into actively managed funds in concert with strong market returns led by small caps and growth stocks. Cerulli believes that the prevalence of money market funds, however, suggests that investors remain vigilant, waiting to see how the pandemic develops.
- European cross-border funds continued their positive momentum following the sell-off in March, attracting €54.2 billion in May. But inflows were lower than the previous month's €65.7 billion. Investors in the cross-border market remained cautious in May, with money market funds and fixed-income funds registering the most net sales, gathering €30.2 billion and €22.5 billion respectively. Net sales for equity funds were muted, gathering €1.8 billion during the month.