I recently delved into the new Russell stability indices and started inspecting the related Russell Factor ETFs. The ETFs began to trade toward the end of May.
If you’ve spent any time researching the so-called “low volatility anomaly” you’re well aware that empirically we have little evidence that investment returns are related to risk..
This is especially the case in the equity markets.
Russell recognized that volatility, beta, and momentum offer additional dimensions of investment style to their well established Value/Growth dichotomy, and have begun publishing “stability” indices that divide the market between Defensive and Dynamic styles. They introduced the indices a few weeks ago and toward the end of May the related ETFs began trading.
The related Russell 1000 factor ETFs are: LVOL, HVOL, LBTA, HBTA, and HMTM. They represent Low Volatility, High Volatility, Low Beta, High Beta, High Momentum. The corresponding Russell 2000 factor ETFs are SLVY, SHVY, SLBT, SHBT, and SHMO.
Since the ETFs began trading only a few weeks ago, and I couldn’t find any supporting historical returns on the Russell website, I used Matrix Returns to compare the ETFs’ portfolio risk to the iShares Russell 3000 ETF, IWZ.
As a reminder, “Matrix Return” is a composite return series based on an index or portfolio’s current holdings and weights. While not representing an actual return history, a Matrix Return is computationally convenient. In this case it allows you to estimate portfolio statistics without having to use a 9-million cell covariance matrix. Keep in mind, although expedient for estimating portfolio risk, Matrix Returns are not very useful for predicting future returns, as past performance is no guarantee of future results.
Portfolio Risk Estimates based on 60 Months of Constituent Returns, June 2006 – May 2011
| ETF | Annualized Volatility | Russell 3000 Predicted Beta |
|---|---|---|
| IWV (Russell 3000) | 19.80% | 1.00 |
| LVOL | 17.40% | 0.86 |
| HVOL | 24.00% | 1.19 |
| LBTA | 14.40% | 0.69 |
| HBTA | 26.30% | 1.31 |
| HMTM | 23.50% | 1.17 |
| SLVY | 22.70% | 1.10 |
| SHVY | 31.70% | 1.50 |
| SLBT | 18.30% | 0.82 |
| SHBT | 38.60% | 1.85 |
| SHMO | 36.00% | 1.32 |
Portfolio Risk Estimates based on 52 Weeks of Constituent Returns, June 14 2010 – June 10 2011
| ETF | Annualized Volatility | Russell 3000 Predicted Beta |
|---|---|---|
| IWV (Russell 3000) | 15.0% | 1.00 |
| LVOL | 13.2% | 0.86 |
| HVOL | 16.9% | 1.08 |
| LBTA | 10.2% | 0.63 |
| HBTA | 20.0% | 1.31 |
| HMTM | 17.2% | 1.13 |
| SLVY | 17.8% | 1.12 |
| SHVY | 23.6% | 1.42 |
| SLBT | 14.6% | 0.86 |
| SHBT | 28.5% | 1.78 |
| SHMO | 22.9% | 1.42 |
Notice that for both the Russell 1000 and 2000, regardless of whether you use monthly or weekly returns the Low Beta and High Beta ETFs exhibit lower and higher volatility, respectively, than do the Low Volatility and High Volatility ETFs. The investment world includes a small but growing community of low volatility investors; it will be interesting to see how appealing they find the volatility ETFs versus the beta ETFs.
These products will also present interesting choices for asset allocation purposes. In general, assuming equal return assumptions the low beta and low volatility ETFs will be more attractive to a mean-variance optimizer. For tactical asset allocation purposes, the high beta and high volatility ETFs offer interesting choices previously not available in portfolios that are not permitted to use derivatives.
Update, June 13, 1:03p Pacific: My analysis did not entail using a risk model. These ETFs were created using Axioma’s risk model, to which I do not have access. I would expect that Axioma’s model would forecast beta and volatility differently from Matrix Return regressions, so I presume the forecast volatilities for the respective low and high volatility ETFs are appropriately lower and higher than those for their corresponding low and high beta ETFs. TMA
Update, June 14, 2:510 Pacific: The iShares Russell 3000 ETF ticker, IWV, has been corrected in the tables. Previously the tables read IWZ, which is the ticker for the Russell 3000 Growth Index.