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CLS: Low-Volatility ETFs, International Markets, What Investors Should Focus On

03/15/2016

Week in Review
Global equity markets finished modestly higher last week. The Russell 3000, a measure for U.S. equity markets, finished up 3% with U.S. small-caps outpacing U.S. large-caps. International markets were modestly higher; the MSCI EAFE was up 4.5% and the MSCI Emerging Markets improved by 6.9%. Regionally, the MSCI Europe was up 3.9%, the MSCI Japan rose by 5.1%, and the MSCI All Country Asia Pacific ex-Japan finished up 5.9%. U.S.  fixed income markets moved lower as the U.S. 10-year Treasury rose by 12 basis points to yield 1.88%.

How Do Low-Volatility ETFs Maintain Their Charm?
2016 has reminded us of the importance of risk budgeting and the value it can deliver to clients. The choppy market movement has created an environment where emotion and sentiment can overtake fundamentals and valuations.

Our X-Factor theme helps us deal with an emotional environment through the use of factor-based ETFs. These ETFs are designed to gain access to risk factors, and can provide additional ways to pare back volatility and enhance diversification in CLS portfolios. Low-volatility ETFs are no exception to this and in fact have been the best performing set of factor ETFs for both U.S. and international equity markets year-to-date.

So, how do low-volatility ETFs maintain their charm? A recent research paper published in the CFA Institute’s Financial Analyst Journal (Li, Sullivan, & Garcia-Feijoo, Volume 72, Number 1, 2016) suggests low-volatility ETFs have benefited by being mispriced in the markets over time. In fact, many of these securities have outperformed their higher-volatility counterparts because they are largely ignored by investors. This results in prices that do not always reflect underlying fundamentals.

What is the key takeaway from this insight? Outside of serving as a tool for paring down risk, low-volatility ETFs can also deliver higher risk-adjusted returns when the underlying securities are mispriced.

Identifying Value in International Markets
For many investors, seeing global equity markets gyrate the way they have this year can be unnerving. As market volatility continues to move from historic lows, emotion can sometimes get the better of us, prompting us to want to “do something” as a knee-jerk reaction instead of focusing on the long term.

Despite the headwinds, global equity markets have shown that now is a great time to take advantage of “bargain sales” for many financial assets. In fact, some of those assets have quietly been moving higher as everything else has continued to fall.

How does CLS identify opportunities within the international space? Much of the work we do revolves around key return drivers, such as economics, fundamentals, technicals, valuations, and risk budgeting.

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