Chris Heakes: When you’re investing in less risky stocks, you tend to have better relative performance on the downside. So, what I mean by that is when the market sells off or corrects low volatility strategies tend to not go down as much as the broad market.

Danielle Neziol: You’re listening to the ETF Market Insights podcast. I’m Danielle Neziol with BMO ETFs. Thanks for joining us. Today, our topic is about factor investing. And if you’re new to factor investing, I’m really glad you’re here to learn more about it. Factor investing is when you invest in a basket of stocks, which all have similar characteristics or fundamentals. And we do this specifically to achieve a specific portfolio makeup, which is expected to behave in a certain way. Examples of factors include value growth, quality, dividend, and low volatility. Today, we’re focusing our discussion on the low volatility factor. And to help us unpack all of this is Chris Heakes, ETF Portfolio Manager, and one of the leads on running the most low volatility strategies. Chris, it’s so great to have you back on the podcast. 

Chris Heakes: Thanks, Danielle. Good to be here. 

Danielle Neziol: So, Chris, we have a lot to talk about on this topic. Let’s just get right to it. I thought we could start the discussion. Could give us a high-level sense of what is a low volatility strategy? What does it mean to be low volatility? And then, what types of investors would consider looking at a strategy like this? 

Chris Heakes: Like you said, a factor investing strategy looks at characteristics of stocks. The characteristic we’re looking at here is, in a general sense, the riskiness of stocks. So a low volatility strategy would be, you know, an equity strategy that tries to invest all things being equal and less risky stocks versus higher-risk stocks. So think of a higher-risk stock, perhaps as a junior miner. Whereas a lower risk stock could be more like a grocer, like a Sobeys or a metro so think a little bit less risk is the selection. And the reason, you know, I think it’s become popular with investors is, you know, one, when you’re investing in less risky stocks, you tend to have better relative performance on the downside. What I mean by that is when the market sells off or corrects, low volatility strategies tend to not go down as much as the broad market. And that sets them up for kind of future performance, because the less you go down, you know, the less kind of whole, you know, quote, unquote, you have to dig out of. And then the other aspect that’s interesting about these, there’s a lot of research and we won’t have time to get into it today. But a lot of these defensive stocks actually provide pretty good returns over the long term. So this is what’s called the lowball anomaly. And, you know, kind of shows that sometimes investors try to chase return a little too much by selecting higher risk stocks. So the opposite of that which can work to your benefit, potentially is, by investing in lower risk stocks, you can actually still get very good returns over the long period.

Danielle Neziol: Great. Thanks, Chris, for that. So basically, when we’re thinking about low volatility strategy, we’re really looking at those less risky stocks that are more defensive. A great point on that low vol anomaly, as the less risk does still mean you’re still participating in markets as they move up. And obviously, during market corrections and sell off, these aren’t going to drop as hard as or as far as the regular market positioning them well, when the market does rebound. Some really good points there. Chris, you work very closely with BMO’s low volatility ETFs. At BMO, we have a very unique approach to how we run a low volatility strategy. Every different shop kind of approaches low volatility in a different way. So very good for investors to kind of do their research and figure out how everybody’s approaching low volatility. Chris, can you walk us through how at BMO how we kind of construct our low volatility strategy? And then what kind of makes this different from other low volatility strategies on the market?

Chris Heakes: For sure, there’s a lot of different strategies on the market now. Low volatility investing has really boomed in a sense over the last 10 years, we actually launched the first low volatility ETF in Canada, and I believe the second in North America. So, we were quite early to the market kind of seeing the benefits that it can provide to investors. But you know, the metric we use, you look at different approaches, they don’t use different metrics to measure and assess risk. What we use is a metric called beta, which is a measure of systematic risk of a stock versus the broad index. The broad index will have, by definition, a beta of one, we’re looking for stocks that have a beta less than one. So that’s kind of where we tend to tilt our positioning. And furthermore, if a stock has a lower beta, you know, less risk like a grocer, perhaps like I mentioned before, they will have a larger weight in the portfolio than securities that have a higher beta. In our strategies securities with a beta above one, so greater risk than the market, we don’t actually hold those in our low volatility strategies. There’s a lot to go in with both our approach and that of the broader products on the street. I think the important thing is you want to make sure you’re true to the exposure, which is holding lower risk stocks. And then the other thing I think you want to do is look out for unintended biases. We have in our portfolio construction, a couple very, relatively simple things, but just to make sure, we don’t get too overexposed to any sector, we have sector caps in our low volatility strategies. And to make sure we don’t have too much say, interest rate exposure, we have further caps on interest rate sensitive sectors. Having a portfolio that has those robust metrics built into it can really make a difference, and you tend to see in the results of these funds.

Danielle Neziol: Great. Thanks for that, Chris. So at BMO, we look at stocks that have a beta less than one so that are less riskier than broad market exposure. And then you and your team do a really good job of keeping those sector caps in place, and making sure that those interest rate sensitive stocks don’t get too highly concentrated in the portfolio as well. Thanks for going over that for us. Let’s continue down this conversation and let’s use our BMO low volatility ETF as an example of what a low volatility portfolio can look like, because it is going to look a lot different than the broad market portfolio will look like. So Chris, what does the portfolio for ZLB the BMO Canadian Equity Low Volatility ETF? How does that look different from the broad Canadian exposure? And then let’s chat a little bit about the US low volatility ETF ZLU maybe chat about how that looks a little bit different than the broad US market? 

Chris Heakes: Both really good examples, for different reasons. Starting in Canada, Canada is known to be a, resource heavy, equity market and economy. That’s been decreasing over time, we’ve been seeing that decrease over time. And, and part of the reason is, quite frankly, some of these sectors haven’t delivered on the expectations of investors. But we’re still quite heavy with our resource trade. As I mentioned, our ZLB, or our low volatility strategy is very underweight in those sectors. So, in a lowball strategy, you’re going to tend to be under with those more aggressive sectors like energy and materials, and have higher weights to more defensive sectors. In Canada, for us, that’s consumer staples, utilities, real estate. Almost a little bit boring, you might say, in comparison to some of the high, higher risk sectors, but it’s really shown to be beneficial in Canada over time. Energy is having a very strong, year this year. But if you look at the trend of some energy, performance over time, it doesn’t always, it’s not always lasting outperformance and that’s what we tend to see. So having kind of the tried and true, slow but steady approach to investing has it benefit. We see that with ZLB, in the US it’s you know, the risk in the US market is largely technology. Now, technology has obviously been on a great run. And you know, we’re bullish on technology in general at BMO. It can add risks into the portfolio, can add hot perhaps higher volatility and draw down the rest of the portfolio. What you see with our US low vol, resources aren’t really a major part of the US stock market to the same extent as Canada. So, you tend to see that biggest underweight coming to technology. And then again, those over weights going to Staples, utilities, and healthcare as well. Healthcare being another sector that the US has that Canada doesn’t have so much. So again, similar themes less aggressive sectors, in this case technology and more kind of defensive sectors such as staples, utilities and health care.

Danielle Neziol: So really, by avoiding those high beta stocks in Canada, the portfolio has a lot less energy, a lot less materials, and in the US, the high beta stocks come of the tech sector. So the low volatility US ETF, a lot less tech and more defensive sectors there. Which brings to a good point that these types of ETFs and low volatility strategy can really work as a good diversification tool as well for portfolios that might be overweight to these broad exposures. So thanks, Chris, for that. Okay, so you know, ZLB the BMO Canadian Equity Low Volatility ETF that was launched a while ago, you mentioned the first low vol ETF here in Canada. So Chris, you’ve seen it performed through market ups and downs, it’s been kind of put to the test. How has it performed? And how can you expect these low volatilities strategies to move as markets go up and down?