Are Low-Volatility Stocks Too Expensive?
Even as global stocks climbed in 2019, market volatility persisted. By some measures, lower-volatility stocks now look quite expensive. But in fact, high-quality stocks that can help protect portfolios can be found at reasonable prices, if you know where to look.
Equity investors had a wild ride in 2019. The MSCI World Index surged by 27% in 2019 in local-currency terms, defying headlines about US-China trade tensions, global political risk and macroeconomic concerns. The gains, however, have been anything but steady. Over the past two years, the market rose or fell by more than 1% on 71 days—a huge increase from 2017, when such sharp gains or losses happened only five times.
Strong Demand for Smoother Return Patterns
Sticking with equities sometimes requires nerves of steel. And not everyone can handle the pressure. That’s why many investors have turned to lower-volatility stocks, which aim to capture equity return potential with smoother trading patterns. Exchange-traded funds with “low volatility” or “minimum volatility” in their names had assets of US$106.8 billion as of December 31, driven by strong inflows of US$28.2 billion through the year, according to Morningstar data.
Their popularity has created a challenge—low-volatility stocks look expensive. By the end of December, the MSCI World Minimum Volatility (Min Vol) Index traded at a price/earnings ratio of 23.9, a 20% premium to the MSCI World (Display, left). In historical terms, the Min Vol is toward the top of its valuation range versus the MSCI World since 2003 (Display, right). For many, that looks like a high price to pay for stability.
But benchmarks can be misleading. Since they focus on a narrowly defined set of lower-volatility characteristics and do not consider valuation, indices can be easily skewed toward more expensive stocks and sectors.