- Growth in Structured Securities
- Growing Emphasis on Low Volatility and Dividends
- Criticisms of Structured Securities
- Demand for Quantitative Skills
- Direction of Quantitative Finance
- When I Realized It Might Be Easier
- Try Again
- The Spreadsheet
- Visualizing the Result
- What It Means and Why It Works: A Nontechnical Overview
- It Doesn't Get Too Complicated
- An Integrated View of Risk Management
Growing Emphasis on Low Volatility and Dividends
Some of 2012’s most successful ETFs were funds that combined these themes, including the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares High Dividend Equity Index Fund (NYSEArca: HDV).
- Low-volatility ETFs debuted in 2011 with the launch of the PowerShares S&P 500® Low Volatility ETF (SPLV). Since inception, SPLV has exhibited 69% of the volatility in the S&P 500 Index [and] outperformed its cap-weighted benchmark in terms of absolute returns.3
In terms of relative performance, SPLV has delivered an excess return of 11.7% compared to the S&P 500. Many other ETFs have been introduced with variations on the low volatility strategy seeking to deliver market exposures measured by volatility rather than traditional cap-weighted benchmarks. Other funds, such as the Wind-haven Portfolios at Charles Schwab & Co., add dynamic allocation strategies, adjusting portfolio allocations based on changing economic conditions. According to the brochure, this form of proactive risk management “strives to capture much of the up markets and less of the down.”
Sage Quant Management filed with regulators in summer 2012 to offer a dividend-focused low-volatility fund to be listed as an ETF. In the filing, the company said that the fund might rely on derivatives such as futures and options contracts to “facilitate trading or to reduce transaction costs.”
That is consistent with the theme of blending dividends and low volatility. And it is consistent with the work of Roger Clarke at Analytic Investors and others who have argued that it may be possible to pick up 40 to 60 basis points of risk-adjusted return. However, funds offered to retail investors have been reluctant to include derivatives simply because a lot of investors view them as dangerous. It appears that attitude is changing, at least when it comes to more conservative types of derivatives. Personally, I believe that including derivatives in the investment toolkit is a step forward in the nature of the funds offered to the retail investor.
After all, derivatives have been utilized in institutional investing for decades to provide exposure to absolute return strategies, long or short, and hedge overlays for pension plans and endowments. Partly, this is in response to the lack of risk management achievable through mean-variance portfolios and their counterparts in the retail space: life cycle and target date funds. It also is partly in response to the need for higher yields to match long-term discount assumptions, which is hard to achieve in a low-yield bond market. Because individual investors face the same challenges, products with derivative components are being offered in more variations by more firms.
That is not to say that everything is going smoothly.