BofA On “Low Vol” – The Next Shoe To Drop
During the turbulent start to the year, there were few places where investors could take refuge from the daily volatility, and as a result, the so-called “low vol” stocks and strategies emerged as one of the preferred hangouts until the transitory turbulence ended. However, even with a return to more normal market levitation, many investors have so far failed to exit the safety of the “low vol” cave, in many cases conveniently padded by dividend payments for stocks that did not promise much upside, excitement or beta, but certainly offered stability.
But, as BofA’s Savita Subramanian warns, “Low Vol” may be the next shoe to drop.
As BofA’s strategist notes, low volatility strategies have seen a parabolic increase in inflows since late 2014 as investors have chased the perceived safety of these strategies. These inflows helped push valuations in Staples and Utilities to elevated levels.
But as she adds, investor sentiment appears to be shifting from a deflation / low growth theme, which benefited defensives and yield plays in 1H16, to an inflation theme, with interest rates rising, inflation expectations picking up and fiscal stimulus beneficiaries attracting investor interest.
As such, Utilities and Staples, which have been two preferred sectors for low vol strategies, were two of the worst performing sectors (along with Telecom) in Q3.
In August, Low Vol funds experienced their first outflow since September of 2014 and appear vulnerable to more outflows if their perceived safety deteriorates as investors shift their focus away from ZIRP (zero interest rate policy) beneficiaries.
As a result of these shifts, BofA concludes, “low vol” has become more risky: the realized volatility of low beta stocks has seen a steady increase over the past several years as shown in the chart below, suggesting low vol is becoming high vol.
Of course, all that would take for this shoe not to drop, would be another market swoon, the result of which would be a tidal wave of money rushing out of high beta, momentum, growth, and so forth, and back into the safety of low vol.
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