Low volatility ETFs outperformed their market-cap weighted counterparts earlier this year after the rapid spread of coronavirus sent shockwaves through markets.
With many countries across Europe looking set to return to lockdown conditions as the result of a second spike, it looks likely low volatility strategies could once again be the option of choice.
There have been brief spikes in volatility since March as the VSTOXX – a measure of volatility for the Euro Stoxx 50 – has been at an elevated level since its peak towards the beginning of the year.
To offset the risk of volatility climbing again, there are a number of smart beta ETFs listed in Europe that employ a low volatility approach. However, the performance of these low volatility strategies can vary greatly depending on certain market conditions.
State Street Global Advisors (SSGA) has a European equity-focused ETF which incorporates a low volatility strategy with the help of Stoxx. Also available in Europe following a similar strategy is BlackRock’s minimum volatility ETF which tracks an MSCI index that implements the factor.
As investors look to increase their exposure to low volatility investment products, how do these two ETFs differ?
ETF
iShares Edge MSCI Europe Minimum Volatility UCITS ETF (MVEU)
SPDR Euro Stoxx Low Volatility UCITS ETF (ELOW)
AUM
€1.1bn
€100m
Benchmark
MSCI Europe Minimum Volatility index
EURO STOXX Low Risk Weighted 100 index
Total Expense Raito (TER)
0.25%
0.3%
Inception date
03/12/2012
24/02/2014
Investment strategy
MVEU tracks the MSCI Europe Minimum Volatility index. The index is composed of selected European companies that have lower volatility characteristics relative to the broader European equity market.
The index has 173 constituents which are determined to be the least volatile stocks compared to its peers in the parent index which has 435 constituents.
To avoid stock dominance by any single company within the ETF, the index limits a max weighting of 1.5% while also having a lower limit for the weighting of 0.05%.
ELOW, however, tracks the Euro Stoxx Low Risk Weighted 100 index. This is comprised of the 100 lowest volatility companies from its parent index, the Euro Stoxx 600.
It offers exposure to small to large cap companies from the eurozone area and are selected based on their volatility scores over the previous 12 months.
Exposure
MVEU is a larger basket of funds and offers exposure to more geographies as it includes the whole of Europe within its strategy. ELOW however only includes the eurozone and therefore has larger weighting to fewer countries.
MVEU’s largest geography exposure is Switzerland which accounts for 20.9% of the fund, ahead of the UK with 17.8% and Germany with 11.5%.
For ELOW, Germany is its largest exposure with 31.4%. The next largest exposure is France with 21.1% whereas it only accounts for 11.2% for MVEU.
As a result of these differing geography methodologies, the top holdings of the funds differ considerably too.
MVEU’s top holding is Swiss materials company, EMS-Chemie with 1.76% weighting while ELOW is led by Finnish engineering company Kone with 1.51%.
While there are no mutual top holdings between the two funds, both have large household names within the 10 largest constituents.
MVEU includes Hermes International (1.53%) and Nestle (1.43%) and ELOW has Unilever (1.28%) which is the third largest stock in the ETF.
From a sector perspective, there are some similarities. Consumer staples is the largest sector exposure for both MVEU and ELOW with weightings of 20.27% and 17.2%, respectively.
Energy is also the smallest exposure for both with 0.77% and 1.12%.
The biggest difference in terms of sector exposure is financials. This sector accounts for 13.3% of MVEU, its third largest, while it only accounts for 5.6% of ELOW, the third smallest.
Given the energy sector’s minimal weightings in both ETFs, this could suggest the ESG ratings could also be favourable for these ETFs.
According to ETFLogic, MVEU has an ESG score of 62.1 while ELOW has a score of 63.1. Both products have exposure to nuclear power and genetically modified organisms.
Performance
Year-to-date, both ETFs are still yet to rebound from the losses experienced in March. At the peak of their loses on 17 March, ELOW was down by 29.8% while MVEU had a slightly smaller loss of 23.7%.
Since then, however, ELOW has shown significant recovery and has reduced that difference of -6.1% to -1.8%. With that being said, both remain down for the year. MVEU has a YTD performance of -6.3% while ELOW has returned -8.1%, as of 18 September.
Over the last five years, however, ELOW has been the outperformer by quite some margin.
Between the beginning of 2016 and 21 February 2020 – when market began to slide – ELOW had climbed 39.1%, 6.7% greater than MVEU.
Therefore, ELOW outperforms in a bullish market but suffers greater losses when the markets become downward trending which might not be ideal if investors are looking to use these ETFs to offset the potential rise in volatility.
With that said, ETFLogic records ELOW to have an annualised volatility rating of 23.1% over the past year while MVEU has a figure of 28.5%.
Conclusion
With the market environment we are currently in and the potential of a second wave of coronavirus hitting Europe, some investors will be looking to minimise the impact of the expected increase in volatility.
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Both of these ETFs’ benchmarks have outperformed their respective parent indices YTD and will therefore likely offer more protection than a market-cap weighted product.
Structurally, the ELOW focuses on the eurozone region as opposed to the whole of Europe and has a smaller basket of securities compared to MVEU.
If the purpose of a low vol ETF in your portfolio is to minimise losses if and when volatility does return, then past records would suggest MVEU is the better option given its lower fee, increased diversity and outperformance in a downward trending market.
ELOW has shown outperformance in upward trending environments but this becomes redundant if the purpose of ETF is to protect you against heightened volatility. However, this would be a good option if one is already investing in an ETF tracking the benchmark’s parent index, the Euro Stoxx 600.
