Managed-volatility funds have yet to be tested
From: marketwatch.com
You won’t find out if your roof is leaking on a sunny day; it takes a storm to see where the problems are.
In the mutual fund world, the last five years of sunny returns and limited volatility have meant that the nascent class of assets known as “managed-volatility funds” has been able to function as a shelter without much of a test on how they would weather a storm.
This week, Strategic Insight noted that assets in managed-volatility funds have surpassed $360 billion, up more than 1,000% from just eight years ago, and the New York research firm acknowledges that there are plenty of other funds that claim to limit volatility that it keeps out of the category because they don’t do enough to actually stand behind their promises.
For all of those funds and the investors who own them, the ride to this point has been smooth, largely because it’s easy to invest in a raging bull market. But with most experts calling for increased volatility next year — more regular occurrences like the market’s flip-flop and direction change in September and October — the funds could be facing their first rainy days and investors are likely to find out if their shelter actually keeps them dry.
Russ Koesterich, global chief investment strategist for BlackRock, said this week that while he believes investors should “stick with stocks” heading into 2015, doing so means “you will have to settle for more sleepless nights and more volatility than we had in 2013 and the first part of this year.” He’s far from alone in that thinking.
Managed-volatility funds, Koesterich noted, have become increasingly popular even though they really haven’t had a long, deep test of their ability to deflect market swings. “The funds make sense, but they’re not a silver bullet,” he said. “If the market is down 30%, [managed-volatility issues] will be down less, but they’ll still be down.…The question is what investors will think when that happens.”
To gauge the potential thoughts, you must first understand investor expectations, and the varying types of funds built to do the job.
“Managed volatility” means different things to different fund companies and investors. For some, it’s “smart-beta funds” or “strategic-beta funds,” industry jargon to suggest that a fund can outperform a traditional index by selecting and weighting the stocks in a portfolio based on various metrics (like volatility, dividends, momentum and more). For others, it simply involves buying low-volatility stocks; the PowerShares Low-Volatility ETF, for example, tracks the least-volatile issues in the Standard & Poor’s 500 Index. In its short history, it has mostly lagged the benchmark index, though it is ahead for 2014.
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Strictly speaking, an investor hoping to find a fund that can live up to the promise implicit in its name or explicit in the marketing materials should look for issues with a stated and explicit goal of mitigating equity volatility; you want volatility to be the focus, rather than a sideline to, say, a large-cap strategy.
Some funds — which seem to be particularly popular in variable-annuity accounts — focus on managing “tail risk,” meaning they try to move to safety and cut volatility when the market is in the throes of a downturn that’s outside of normal expectations. They act when the market seems to be in crisis, as opposed to a “low-volatility fund,” which may use simple strategies like rebalancing to try to smooth out the ride in all conditions, without ever making big moves when the market goes nutty.
