So much for the idea that you could get premium returns from stocks with reduced risk.
Low-volatility exchange-traded funds had a great run of doing exactly this. The BMO Low Volatility Canadian Equity ETF (ZLB) had a cumulative return of 85.5 per cent for the five years to Nov. 24, while the BMO S&P/TSX Capped Composite Index ETF (ZCN) made 32.3 per cent. But lately, the low volatility strategy has lagged. ZLB was up 5.5 per cent for the past 12 months, while ZCN was up 12.3 per cent.
ZLB crushed ZCN for years by holding stocks that are less volatile in comparison to the broader market. The back story here is that investors were feeling nervous after the market crash of 2008-09 and gravitated to the kind of stable blue chip dividend stocks that began turning up in low-volatility portfolios. These stocks soared in price and took low volatility funds along with them.
Lately, investors have been less risk averse and more growth-oriented. They're selling some of the blue chip dividend stocks that did well for them in the past few years and looking at stocks that offer more potential for capital gains. Year to date, the top performing sector on the TSX is the decidedly dividend-unfriendly materials sector. Next is energy, another growth-oriented sector.
The outcome of the U.S. election may have also hurt low volatility stocks. Bond yields have surged higher, and that's bad for dividend stocks in sectors like utilities, pipelines, telecom and real estate. There's also growing optimism – for now, anyway – of a U.S. economic revival driven by president-elect Donald Trump's plans for infrastructure spending and deregulation. This could further weigh on low volatility stocks.
Low volatility ETFs are widely available and have attracted billions from retail investors who loved the idea of tamping down risk while trouncing the broader stock market. ZLB alone has grown to $1.3-billion in assets, compared to $1.6-billion for the older, more established ZCN.
But it's now becoming apparent that low volatility is a strategy like any other – it will have both up and down cycles. The takeaway for investors is that low-volatility funds are a way to play a risk-averse market. Diversify with a broader index ETF to capture the kind of risk-embracing market we've seen lately.