Whether it was the Adani-Hindenberg saga for domestic stocks or the ongoing Silicon Valley Bank closure for US shares, equity markets worldwide have been experiencing volatility. Due to such events, many investors rely on portfolios with low volatility as these baskets perform relatively better in turbulent markets and typically exhibit lower drawdowns aiding in long-term performance. Mirae Asset MF is the latest to join the ‘low volatility’ smart-beta space with the launch of Mirae Asset Nifty 100 Low Volatility 30 ETF. The New Fund Offer (NFO) closes on March 21, 2023. The scheme reopens for continuous sale and repurchase on March 27, 2023. With the ‘low-vol’ smart-beta product space already having ten products, how different it will be the Mirae Asset Nifty 100 Low Volatility 30 ETF? And, should you invest? Let’s find out.
Importance of low volatility portfolio
Low volatility (low-vol) is an interesting factor/characteristic of a group of stocks that is important in explaining their risk and return. Such a factor captures returns to stocks with lower-than-average volatility, beta etc. While different style factors perform differently across periods, the below chart reveals how low volatility has not given negative return in the last five calendar years, unlike other factor peers i.e. value, momentum, dividend yield and quality.
Low volatility aims to generate an excess return based on the portfolio of stocks with lower-than-average volatility. The Nifty100 Low Volatility 30 index forms the underlying basket of stocks that most existing smart beta ETFs track. The index measures the performance of the low-volatile securities in the large market capitalization (large-cap) segment. The index is reviewed on a quarterly basis. At the time of review, if the existing constituent of the index is ranked within the top 60 based on the low volatility score, then the stock is retained in the index. The weight of securities is based on the volatility score.
For those who haven’t heard about smart beta ETFs, these aim to potentially combine the benefits of both active and passive investing. Smart beta ETFs are gaining popularity across the globe as they have the potential to generate alpha by using different factors.
Coming back to the low volatility stocks, while at turbulent times, these stocks fall relatively far less (see chart) than the higher volatile stocks. Do note that these stocks during turbulent times, compensate for less than a relative run-up during the boom.
Nifty 100 Low Volatility 30 index has done relatively better than other factors over the last 15 years or so (see chart).
On portfolio construction, at this moment, Nifty 100 Low Vol 30 index is skewed towards Fast Moving Consumer Goods (FMCG) stocks and healthcare compared to Nifty 100 index. Other top weights are IT, Financial Services, Automobiles, Power, Oil & Gas and Consumer Durables (see chart).
For those curious about the Nifty 100 Low Vol 30 index portfolio constituents, the top holdings are Nestle, ITC, TCS, Dr Reddy’s, Bajaj Auto, HCL Tech, Britannia, HUL, Cipla, NTPC, L&T.
How have existing low volatility ETFs performed
Except for ICICI Pru Nifty 100 Low Volatility ETF, none of the other existing products have a 3-year history. The Nifty 100 Low Vol passive products were launched only in the last two years. Hence, the return analysis presented below is based on the short-term NAV movement (see below).
In the short-term, ie 1, 3, and 6-month periods, we can see (in the below chart) how returns are usually similar for these ETFs and index funds. These periods are marked by negative returns, in sync with broader markets.
Over the long-term, ICICI Pru Nifty 100 Low Vol ETF has generated 20.61 per cent CAGR in 3-year period and 11.28 per cent CAGR in 5 years. On both counts, the smart beta ETF has outperformed equity large-cap fund category (3-year: 19.63 per cent CAGR; 5-year: 10.30 per cent CAGR).
Investors are understandably bracing for volatility after a sustained bull market phase and eye stock portfolios that exhibit fewer performance swings.
Low-volatility investing aims to provide better risk-adjusted returns over time ie a relatively smoother ride. Also, it is seen that low-volatility stocks generally tend to hold up better when markets decline rapidly, but the flip side is that they may lag during strong market rallies.
If you are considering a low vol fund, monitor the fund management fee. Existing low vol index funds come with about a 1 per cent expense ratio, while ETFs are cheaper at 0.3-0.6 per cent.
Due to its open-ended nature, the inflows and outflows will determine the benefit given the extent of tracking error.
While investors looking to take exposure in stable companies with low volatility can consider low-vol ETFs, having moderate return expectations, especially if the markets rally relatively from here on.