The US equities low-volatility index saw a record shake-up in constituents during the coronavirus market crisis, a new S&P Dow Jones analysis shows.
At the latest low-volatility index three-month rebalancing date on May 15, the study says 64 stocks “rotated out” of the S&P 500 Low Volatility Index.
“For context, the median annual turnover [of the low vol index] for the last 28 years has been 64%,” the S&P report says.
As well as the large number of individual stock changes, the low volatility index registered a significant sectoral shift post the first bout of coronavirus economic disruption.
“Low Vol’s weighting in Utilities fell by 21%, Real Estate by 16%, and Financials by 11%, while Health Care (+21%) and Consumer Staples (+13%) witnessed double-digit gains,” the study says.
Low volatility stocks have been linked to long-term outperformance of the wider benchmark but the recent S&P reshuffle shows how rapidly factor indices can skew off-message.
The report, authored by S&P director index investment strategy Fei Mei Chan, says the latest low vol “rebalance is a good demonstration of how dynamic the index can be, and its size is a function of two things”.
“First, all factor indices are subject to drift. They best embody the factors they’re designed to track immediately after they’re rebalanced. In periods of high dispersion, factor drift is especially likely, and dispersion in the S&P 500 hit near-record levels in March,” Mei Chan says. “Second (and unsurprising in view of the level of dispersion), the volatility of the S&P 500 also spiked since Low Vol’s last rebalance.”
While the COVID-19 uncertainty hit the whole index, the volatility increase was much higher in some sectors than other.
“… intra-sector volatility for Energy was especially dramatic, and that for Health Care and Consumer Staples more muted,” the study says.
Early in May, the London Stock Exchange index provider, FTSE Russell, reported that low volatility stocks went against type during the peak market uncertainty in March by underperforming.
“So, why didn’t (low) Volatility protect portfolios? The reason is that the defensive move during this sell-off was not a move to low volatility stocks, but rather one to stocks expected to do well during the COVID-19 crisis, regardless of their volatility,” the FTSE Russell analysis says.
“Furthermore, this market sell-off had well-known causes and investors took this into account when positioning their portfolios.
“Not all sell-offs are the same, and this one was certainly characterized by idiosyncratic reaction to the virus crisis itself.”