could resist investments that are "smart"?
They certainly sound better than "dumb
investments" or "idiotic funds."
who wouldn’t want to cut "volatility" in
their investments? In other words, who wouldn’t want
protection from a stock market crash such as those in
2000 and 2008, which turned 401(k)s into 201(k)s as
stocks plunged more than 50 percent.
company professionals who create mutual funds and
exchange traded funds (ETFs) realized after those
horrible crashes traumatized people that if a fund could
promise to take some of the pain of volatility away,
their companies would have a hot investment product. And
indeed they do.
2008, investment companies have been churning out
different forms of funds known as "smart
beta," and there’s now more than $500 billion in
them. They are known as low- or minimum-volatility
funds, designed to hold stocks that are less likely to
crash as severely than the stock market as a whole.
concept sells. Investors are drawn to them at a time
when CD and bond interest rates are minuscule, and
memories of those stock market crashes still keep people
awake at night.
of fast-growing stocks such as Amazon or Tesla, the
low-volatility funds tend to pick blue chip companies,
known for their stable profits and performance —
companies such as AT&T and Johnson & Johnson.
The idea is that in a recession, consumers might not
shop for a new tech gadget, but they will still buy
toothpaste, diapers and laundry detergent.
trouble is that whenever any investment becomes ultra
popular — even a stable company — it ultimately will
become risky if people like it too much. And that was a
common warning from investing pros who spoke this week
at the annual Morningstar ETF Conference in Chicago.
analysts mentioned that the dividend-paying stocks that
make up low-volatility funds have been attracting so
much money from risk-averse people lately that demand
has pushed the stock prices way up. And when stocks or
funds get too pricey, they can fall and fall hard. That
realization has made some investors leery of the popular
sectors that are favorites in low-volatility funds:
utilities, real estate investment trusts (REITs) and
consumer staples such as Procter & Gamble.
so far, the uptrend remains. During the first seven
months of this year, one of the most popular
low-volatility funds — the iShares Edge MSCI Minimum
Volatility USA (USMV) fund — delivered a 13.26 percent
gain. That’s huge compared with less than 8 percent in
a Standard & Poor’s 500 index fund.
of being lulled by the gain, however, Morningstar
analyst Ben Johnson has warned that an examination of
data back to 1994 shows that when the MSCI USA Minimum
Volatility Index has been pricey, there have been
declines. And he noted that at the end of July, the
index was the priciest since its launch in June 2008.
also point out that the low volatility approach could be
vulnerable if the Federal Reserve starts raising
interest rates this month or in December. If interest
rates start climbing, people who bought utilities and
REITs for dividend income while interest rates were
remarkably low will see safer alternatives for their
money. They may sell utilities and REITs, as they have
in the past when interest rates headed up, and put money
into bonds and CDs instead. If the utilities, REITs and
other dividend-payers in low-volatility funds are
heavily sold, the low-volatility fund values also will
low-volatility funds are relatively new, they have not
been tested during a period of rising interest rates —
the type of period that may be coming in the months
people could become unnerved if they bought
low-volatility funds thinking the funds would always be
a defense against stock market losses. Like every type
of investment, low-volatility stocks ride cycles and
will go up and down. But most investors don’t give
funds a chance when they act differently than assumed.
Hsu, chairman of Rayliant Global Advisors, told a
Morningstar audience that humans have a lousy track
record with funds: "They add onto what they’ve
heard others say made great money." Then, the cycle
turns and "they sell and cause themselves great