Quants Corner

Understanding the rise of low volatility strategies in asset management

The rise of passive investment and ETFs are helping people to increase spread across investment types. However it is quantitative investment strategies that are having their golden moment, with a record high number of investors directly using results to increase efficiency, and risk adjust returns. Over the past decade, quantitative investment strategies or –popularly named Smart Beta strategies- have seen the most interest aided by the rise in passive investment and ETFs.

There are a multitude of Smart Beta strategies in existence within the industry. With momentum, value and risk parity strategies seeing an increase in popularity in the last few years. One however stands out, in a recent survey – Low Volatility. Low Volatility strategies have been the most used smart beta strategy by asset owners in 2019, after multi-factor strategies - which provides a diversified way of investing using varying quantitative factors - Data shows investors are more interested in increasing their diversification while implementing strategies that can generate a reduction in risk of their portfolios.

To better understand the evolution of low volatility funds, we decided to search for different fund providers, fund names & benchmark indices, to identify funds which have a clear low volatility mandate using our EPFR database. According to our estimations at the end of May 2019, there are 204 low-volatility funds globally available, a staggering ten-fold increase compared to 2013 in terms of number of funds. In terms of Assets under Management (AuM), there is currently $130 billion USD invested in this type of funds (Chart -1).

Chart 1- Total AuM in millions USD invested in Low-Volatility Funds

The total flows going into low volatility products are also on the rise, as seen in Chart 1.0. In six years (2013 and 2019), the cumulative flows added up to 160% of the initial AuM invested in these products according to EPFR database, see Chart -2.

Our research showed the cyclicality of the flows into low-volatility products and its relation with CBOE Volatility Index (VIX) A rapid increase in flows to low volatility funds in 2013, stalled until mid-2014 and regained pace up to the 3rd quarter of 2016 where the flow was continuous thereafter. Noticeably, a ‘stall’ period between 2017 and 2018, was followed by an acceleration of flows into low volatility funds from 2018 to 2019. According to chart 2.0, it appears investors tend to increase investments in low volatility funds, after periods of high volatility and reduce their investment pace of in times of lower volatility.

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