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How to Play Increasing Volatility in a Charged-Up Election and Locked-Down Economy
- Low Volatility strategies delivered excess performance in September, as global equities experienced a pullback after recovering their pre-crisis all-time highs.
- Investors concerned with the potential for election outcomes and COVID-19 to drive uncertainty can consider a Low Volatility approach.
- SPDR® ETFs offer a complete range of Low Volatility exposures (global, US and eurozone) to de-risk the portfolio heading into year end. Read our new SPDR Smart Beta Compass to learn more.
Global equities experienced a significant drawdown in early 2020 as the onset of COVID-19 and the associated economic shutdown sent markets tumbling. However, at the end of August 2020, global equities (MSCI World Index) had returned to their pre-crisis all-time highs and were up 5.34% year to date.1
At that time (25 August 2020), we posed the question in our Strategy Espresso Have we come too far, too fast? with the recovery, suggesting that investors seeking to remain long at those valuations could “consider a Global Low Volatility allocation to position against the negative effects of lingering uncertainty.“ This turned out to be a timely note as market benchmarks for US equities (S&P® 500 Index -3.84%) and eurozone equities (EURO STOXX® Index -1.81%) sold off in September. The Low Volatility ETFs in these associated market benchmarks outperformed by 2.05% (SPDR® S&P® 500 Low Volatility UCITS ETF) and 1.71% (SPDR® EURO STOXX® Low Volatility UCITS ETF).2
However, many investors may have missed this opportunity, since low volatility strategies failed during the COVID-19 sell-off in Q1 to deliver their historically observed drawdown protection. This can largely be attributed to idiosyncratic characteristics of the pandemic’s impact on equity markets. A careful examination of the historical returns of a Low Volatility approach, in both US and eurozone equities, explains that the March 2020 performance was an outlier and more recent performance (September 2020) is more in line with the historical trend.
Figures 1 and 2 show the relationship of relative (excess) returns of a Low Volatility approach versus the market cap benchmark (“market return”) for both US (Figure 1) and eurozone (Figure 2) equities on a monthly basis since the inception of the respective Low Volatility indices. In both instances, there is a strong negative correlation between the excess returns of a Low Volatility strategy and the market return. This would suggest that when the market was down, Low Volatility historically delivered outperformance (and vice versa). Looking at the correlation coefficients for each suggests a strong relationship (US 0.3452, eurozone 0.3487).
As we discussed in August, we believe the recovery should encourage equity investors. However, there are still notable events on the horizon as we head into year end (e.g. US election outcomes and ongoing COVID-19 impact), which may continue to worry investors about equity price sensitivity at the current levels. Cautious investors may begin to favour a Low Volatility approach, especially as strategies such as US and eurozone Low Volatility have returned to their historical trend, in terms of relative performance. Investors seeking a diversified approach to remaining long at these valuations can consider a Low Volatility allocation to position against the negative impacts of lingering uncertainty.
How to Play this Theme
SPDR offers a suite of Low Volatility strategies that follow a simple and yet effective methodology. In one simple trade, investors can introduce a defensive posture to their global equity allocations using the SPDR® S&P® 500 Low Volatility UCITS ETF or SPDR® EURO STOXX® Low Volatility UCITS ETF . To learn more about these ETFs, and to view full performance history, please click on either fund name to be taken to its fund page.
Now available: SPDR Smart Beta Compass – Q4 2020
Our newly launched SPDR Smart Beta Compass combines analysis of equity factor performance, Smart Beta ETF flows and institutional investor positioning to provide a market review and outlook for factor-conscious investors.
Click here to read the SPDR Smart Beta Compass.
Figure 1: Monthly US Low Volatility Active Return vs. Market Return (Since May 2011)
Figure 2: Monthly Euro Low Volatility Active Return vs. Market Return (Since October 2012)
Flows
European-Domiciled ETP Segment Flows (Top/Bottom 5, $mn)
European-Domiciled ETP Asset Category Flows ($mn)
Sources: Bloomberg Finance L.P., for the period 15-22 October 2020. Flows are as of date indicated and should not be relied upon as current thereafter.
1 Source: Bloomberg Finance LP, as of 30 September 2020.
2 Source: State Street Global Advisors, Morningstar as of 30 September 2020.
Marketing Communication. For Professional Client Use Only.
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2015149.147.1.EMEA.INST
Exp. Date: 31/01/2021