‘Low vol’ funds attract more than $10bn of inflows this year
Equity funds that promise to shield investors from market volatility attracted inflows for the 11th straight month in May, making them a marketing success story for the asset management industry but triggering warnings that they may not behave as expected in a future market downturn.
More than $10bn has now flowed into US-listed “low vol” funds this year so far, more than the total for the whole of 2015, with two BlackRock exchange traded funds accounting for more than half of the total raised.
These and similar funds say they have picked stocks that will fall less steeply than the market in a downturn — and go up less than the market during a bull run — but some investors expressed concern that their newfound size could change the behaviour of the underlying stocks.
“Low volatility stock funds are probably the most dangerous thing out there”, said Jeffrey Gundlach, founder of DoubleLine, the Los Angeles asset manager.
“The big problem in markets is always the same; not things that are known to be risky but things that are thought to be safe that turn out to be risky,” he said. “People that own them think that they don’t go down. It’s when you think it’s safe and it starts going down that you get mass selling.”
The research group Morningstar classifies 25 ETFs as low volatility funds, with $35bn in assets at the end of April, $9.8bn of which had been invested in the first four months of the year. The pace of inflows picked up sharply in February, after stock markets gyrated with fears of a global recession.
Money has kept being added, even though the Vix index of market volatility has fallen back close to a one-year low. The six largest low vol ETFs alone had further inflows of $1.6bn in May.
The $13.1bn iShares Edge MSCI minimum volatility USA fund from BlackRock, which has doubled in size in the past 12 months, has had inflows on all but three days so far this year. A $7.1bn sister fund that runs a minimum-volatility portfolio of non-US stocks has had inflows on every day but one this year.
Andrew Ang, head of factor investing strategies at BlackRock, said savers in low vol funds are less likely to sell in a panic if their fund is insulated from the worst of a market swoon, and he predicted demand for low vol funds would remain robust as long as the world remains uncertain.
“The times when minimum volatility strategies perform the worst is when there is no risk of Britain leaving the EU, no refugee crisis in Europe, Greece is all good, there is no Isis, no al-Qaeda, oil is back to $50 or $60, China is growing at double digits again and it is the 1970s ‘peace, man’ everywhere,” he said.
BlackRock also dismissed concern that inflows into low vol funds would change the dynamics of the underlying portfolios. Its US low vol ETF accounted for 0.03 per cent of the market capitalisation of the 198 stocks in its portfolio.
The valuation of the stocks in that portfolio, however, has risen above the average for the market this year, amid rising demand for defensive stocks more generally, potentially making them more vulnerable to a sell-off than previously, according to some investors.
Peter Tchir, managing director at Brean Capital, said the assumptions underlying the low vol label were based on “historical data and historical correlations, but so much money has flowed in that we could see a breakdown of these traditional relationships, particularly if they are held by nervous buyers who have only decided to stay in the market on the thesis that they will outperform”.
Earlier this month, Deutsche Bank identified low volatility as one of the most crowded trading strategies.
“Low volatility appears to be as crowded as it was during the financial crisis when investors simultaneously plunged into defensive, low volatility stocks,” analyst Javed Jussa and colleagues wrote in a research report.