Low-volatility value investing
Exchange-traded funds (ETFs) focused on low-volatility stocks have been popular with investors worried about global economic uncertainty and equity valuations. Yet it’s important for investors to understand exactly what they’re getting—and not getting—with low-volatility strategies.

Although single-factor ETFs that focus only on low-volatility stocks are designed to limit drawdowns and overall volatility, academic research posits that low-volatility strategies will actually underperform the market over long periods. When low-volatility ETFs do outperform, it may be due to an emphasis on rate-sensitive sectors, or because of an overlap with other factors such as value that have long-term performance premiums. It’s important to remember, though, that low-volatility approaches and value investing aren’t the same thing, even though they may perform similarly at times.
The low-volatility anomaly
Low volatility is often included as a factor of a stock’s expected return, along with other key characteristics such as size, value, and profitability. However, Dimensional Fund Advisors, the subadvisor for John Hancock Multifactor ETFs, believes low-volatility strategies should have lower expected returns than the market.¹
Dimensional notes that low-volatility strategies have performed in line with the overall market in recent decades, but with less volatility, which has resulted in attractive risk-adjusted returns. This is sometimes called the “low-volatility anomaly.” Yet, going back to 1928, there have been long periods when low-volatility stocks underperformed the market, according to Dimensional’s research.
In fact, Dimensional found that outperformance and underperformance of low-volatility stocks were driven by other factors that have documented performance premiums: size, relative price (value), and profitability. For example, there have been times when low-volatility strategies outperformed because they overweighted value stocks and captured the value premium.² Still, low-volatility strategies have inconsistent exposure to value stocks,³ and they are sometimes overweight growth stocks. Therefore, investors probably shouldn’t count on low-volatility strategies having consistent exposure to the value premium.
Rate-sensitive sector tilts and turnover
There are many ways to construct low-volatility strategies using rules-based indexes with varying degrees of complexity. A simple approach is to focus on stocks that tend to fluctuate less than the market. For example, the S&P 500 Low Volatility Index selects the 100 least volatile stocks from the S&P 500 Index, then gives greater weightings to stocks with lower volatility as measured by standard deviation over the previous 12 months.⁴
Standard deviation measures a security’s tendency to fluctuate in price. Stocks with high volatility—such as a young, speculative biotech company—tend to see big swings. On the flip side, low volatility suggests an established company with a relatively stable business and stock price. Also, low volatility tends to persist in the short term, according to academic research.⁵ In other words, low volatility in past periods is a reasonably good indicator of low volatility in the future.
However, a relatively simple approach of selecting and weighting low-volatility stocks can lead to some quirky portfolio characteristics that investors should be aware of.
First, the performance of low-volatility strategies may be affected by their tilts to particular sectors. For example, the S&P 500 Low Volatility Index has nearly a quarter (24.3%) of its sector allocation in utilities, compared with just 3.3% for the S&P 500.⁶
This raises a larger issue that low-volatility stocks tend to be sensitive to interest rates.⁷ The performance of the S&P 500 Low Volatility Index has benefited from its overweights to rate-sensitive utilities and real-estate stocks over the past year with 10-year U.S. Treasury yields falling from about 3.25% to about 1.5% currently.
Finally, from a portfolio implementation perspective, low-volatility strategies that rebalance quarterly can have significant turnover, and those transaction costs and potential tax implications can make them more expensive to manage.⁸
Know what you own
It’s easy to understand why low-volatility ETFs appeal to investors who want some built-in downside protection for their equity exposure. And the evidence suggests that low-volatility strategies generally deliver on their promise of being less volatile than the market. As a result, over longer periods, they may lose less when the market falls, but may lag during strong bull markets.
But the recent outperformance of low-volatility strategies may cause some investors to think they’ve found the holy grail of investing: lower volatility and higher returns in all market cycles, resulting in superior risk-adjusted performance. However, investors should be cognizant that the recent performance of low-volatility stocks has been driven by sector overweights to rate-sensitive sectors in a falling-rate environment.
Also, over longer periods, the outperformance of low-volatility strategies may be due to overlap with the performance premiums of other factors such as value. And that’s why we think it’s important not to equate low-volatility strategies with value investing.
1 “Low Volatility Strategies,” Dimensional Fund Advisors, August 2014. 2 “Research Brief: Low Volatility Strategies,” Dimensional Fund Advisors, August 2014. 3 “Low-Vol Strategies Are Not the Same as Value, Profitability,” Morningstar, 11/29/2018. 4 S&P 500 Low Volatility Index fact sheet, as of 7/31/2019, us.spindices.com. 5 “Low Volatility Strategies,” Dimensional Fund Advisors, August 2014. 6 S&P 500 Low Volatility Index and S&P 500 Index fact sheets, as of 7/31/2019, us.spindices.com. 7 “Does interest rate exposure explain the low-volatility anomaly?” Joost Driessen, Ivo Kuiper, and Robbert Beilo, September 2017. 8 “Examining Diversification in the Context of Low-Volatility Funds,” Morningstar.com, 12/19/2018.
Important disclosures
Important disclosures
The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States.
The S&P 500 Low Volatility Index measures performance of the 100 least volatile stocks in the S&P 500. The index benchmarks low volatility or low variance strategies for the U.S. stock market. Constituents are weighted relative to the inverse of their corresponding volatility, with the least volatile stocks receiving the highest weights.
S&P Select Sector Indices: All components of the S&P 500 are assigned to one of the 11 Select Sector Indices, which seek to track major economic segments and are highly liquid benchmarks. Stock classifications are based on the Global Industry Classification Standard (GICS®). Capping is applied to ensure diversification among companies within each index.
Value stocks may decline in price. Diversification does not guarantee a profit or eliminate the risk of a loss.
It is not possible to invest directly in an index. Past performance does not guarantee future results.
John Hancock ETFs are distributed by Foreside Fund Services, LLC in the United States, and are subadvised by Dimensional Fund Advisors LP in all markets.. Foreside is not affiliated with John Hancock Investment Management Distributors LLC or Dimensional Fund Advisors LP.
John Hancock Multifactor ETF shares are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
Dimensional Fund Advisors LP receives compensation from John Hancock in connection with licensing rights to the John Hancock Dimensional indexes. Dimensional Fund Advisors LP does not sponsor, endorse or sell, and makes no representation as to the advisability of investing in, John Hancock Multifactor ETFs.
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