BMO Canadian ETF Dashboard

— as of August 31, 2018 —

Combining Low Volatility and Value – Smart Beta Use Study

Chris Heakes

Combining Low Volatility and Value – Smart Beta Use Study

Summary of Trade Ideas

Low-Volatility ETFs: BMO Low Volatility Canadian Equity ETF (Ticker: ZLB) BMO Low Volatility US Equity ETF (Ticker: ZLU) BMO Low Volatility International Equity Hedged to CAD ETF (Ticker: ZLD) Value ETFs: BMO MSCI Canada Value Index ETF (Ticker: ZVC) BMO MSCI USA Value Index ETF (Ticker: ZVU) BMO MSCI EAFE Value Index ETF (Ticker: ZVI)

Trade Opportunity:

The rise of smart beta Exchange Traded Funds (ETFs) has created more possibilities for investors to customize portfolios to deliver specific return and risk outcomes that better align with their objectives. Well-constructed smart beta ETFs aim to improve upon the return or risk level (or both), relative to the broad index. BMO Global Asset Management is the market leader and largest provider of smart beta ETFs in Canada. This month we introduce an attractive smart beta pairing to consider when implementing systematic equity exposure, with the objective of improving risk-adjusted results relative to broad market indexes.

Pairing Low Volatility and Value creates a compelling mix, capitalizing on the advantages of each, while also taking into account their weaknesses. Value is a higher risk/alpha strategy that tends to perform well in periods of economic expansion. Low Volatility, on the other hand, is a lower risk/defensive strategy that tends to outperform the index in periods of equity contraction.

Why Value Now?

Value tends to perform best in expansionary economies. While the current market is now 10 years into the recovery cycle (the longest on record), global economic trends remain robust. A continuation of growth would be beneficial for Value strategies. BMO’s suite of Value ETFs has an average beta of 1.1 and is positioned for good performance should the late-cycle rally continue. In 2016 and 2017, an example of a recent strong equity market, the Enhanced Value indexes returned an average 3% better than the broad index on an annual basis (12.4% annual performance, versus 9.2% for the MSCI World). In 2008, an example of a bear market, the maximum drawdown was the same for Enhanced Value and the broad index, at -37%. Value stocks are historically cheap, while broad market index valuations are becoming stretched. Value strategies are poised to perform well should the economic backdrop remain robust, or improve further. The underlying index (MSCI) also utilizes 3 different metrics, offering a diversified and efficient way to deliver this exposure.

Why Low Volatility Now?

Low Volatility is the most defensive factor offered, and tends to outperform the broad index in periods of equity contraction. In 2008, Low Volatility outperformed broad indexes by an average of 11%. Conversely, in 2016 and 2017, Low Volatility underperformed, partially due to rising interest rates as well as investors’ preference for growth stocks, particularly IT. Low Volatility performance has bounced back over the past 6 months, signalling an adjustment to higher interest rates. Most importantly though, should market volatility increase in future months, Low Volatility will be poised to outperform once again.

Sep-2018-Heakes-Combining-Low-Volatility.jpg#asset:1558

In combination, Value and Low Volatility have the lowest correlations of all smart beta ETFs offered, varying from 0.50 to 0.65.  Using MSCI data, a 50% Value/50% Minimum Volatility strategy achieves an annualized average return 2.3% higher than the broad index, while reducing risk by 10% relative to the broad benchmark. Diversifying using these 2 factors provides a smoother return experience, while potentially adding significant alpha over the longer timeframe.

Sep-2018-Heakes-Correlation-Benefits.jpg#asset:1555

The average correlations between factors are the lowest between Low Volatility and Value. Combining these factors will potentially enhance portfolio diversification and improve upon broad beta index ETFs.

BMO ETFs offers a wide range of smart beta ETFs that feature both Value and Low Volatility: Smart Beta Exposure Geography Offered Tickers
Low Volatility Canada, US, EAFE, Emerging Markets ZLB, ZLU/ZLH, ZLI/ZLD, ZLE
Quality US, Europe, Global ZUQ, ZEQ, ZGQ
Value Canada, US, EAFE ZVC, ZVU, ZVI
Dividend Canada, US, EAFE ZDV, ZDY/ZUD, ZDI/ZDH
Equal Weight Select Canadian and US Sectors Find in ETF Roadmap
Chris Heakes

Combining Low Volatility and Value – Smart Beta Use Study

Summary of Trade Ideas

Low-Volatility ETFs: BMO Low Volatility Canadian Equity ETF (Ticker: ZLB) BMO Low Volatility US Equity ETF (Ticker: ZLU) BMO Low Volatility International Equity Hedged to CAD ETF (Ticker: ZLD) Value ETFs: BMO MSCI Canada Value Index ETF (Ticker: ZVC) BMO MSCI USA Value Index ETF (Ticker: ZVU) BMO MSCI EAFE Value Index ETF (Ticker: ZVI)

Trade Opportunity:

The rise of smart beta Exchange Traded Funds (ETFs) has created more possibilities for investors to customize portfolios to deliver specific return and risk outcomes that better align with their objectives. Well-constructed smart beta ETFs aim to improve upon the return or risk level (or both), relative to the broad index. BMO Global Asset Management is the market leader and largest provider of smart beta ETFs in Canada. This month we introduce an attractive smart beta pairing to consider when implementing systematic equity exposure, with the objective of improving risk-adjusted results relative to broad market indexes.

Pairing Low Volatility and Value creates a compelling mix, capitalizing on the advantages of each, while also taking into account their weaknesses. Value is a higher risk/alpha strategy that tends to perform well in periods of economic expansion. Low Volatility, on the other hand, is a lower risk/defensive strategy that tends to outperform the index in periods of equity contraction.

Why Value Now?

Value tends to perform best in expansionary economies. While the current market is now 10 years into the recovery cycle (the longest on record), global economic trends remain robust. A continuation of growth would be beneficial for Value strategies. BMO’s suite of Value ETFs has an average beta of 1.1 and is positioned for good performance should the late-cycle rally continue. In 2016 and 2017, an example of a recent strong equity market, the Enhanced Value indexes returned an average 3% better than the broad index on an annual basis (12.4% annual performance, versus 9.2% for the MSCI World). In 2008, an example of a bear market, the maximum drawdown was the same for Enhanced Value and the broad index, at -37%. Value stocks are historically cheap, while broad market index valuations are becoming stretched. Value strategies are poised to perform well should the economic backdrop remain robust, or improve further. The underlying index (MSCI) also utilizes 3 different metrics, offering a diversified and efficient way to deliver this exposure.

Why Low Volatility Now?

Low Volatility is the most defensive factor offered, and tends to outperform the broad index in periods of equity contraction. In 2008, Low Volatility outperformed broad indexes by an average of 11%. Conversely, in 2016 and 2017, Low Volatility underperformed, partially due to rising interest rates as well as investors’ preference for growth stocks, particularly IT. Low Volatility performance has bounced back over the past 6 months, signalling an adjustment to higher interest rates. Most importantly though, should market volatility increase in future months, Low Volatility will be poised to outperform once again.

Sep-2018-Heakes-Combining-Low-Volatility.jpg#asset:1558

In combination, Value and Low Volatility have the lowest correlations of all smart beta ETFs offered, varying from 0.50 to 0.65.  Using MSCI data, a 50% Value/50% Minimum Volatility strategy achieves an annualized average return 2.3% higher than the broad index, while reducing risk by 10% relative to the broad benchmark. Diversifying using these 2 factors provides a smoother return experience, while potentially adding significant alpha over the longer timeframe.

Sep-2018-Heakes-Correlation-Benefits.jpg#asset:1555

The average correlations between factors are the lowest between Low Volatility and Value. Combining these factors will potentially enhance portfolio diversification and improve upon broad beta index ETFs.

BMO ETFs offers a wide range of smart beta ETFs that feature both Value and Low Volatility: Smart Beta Exposure Geography Offered Tickers
Low Volatility Canada, US, EAFE, Emerging Markets ZLB, ZLU/ZLH, ZLI/ZLD, ZLE
Quality US, Europe, Global ZUQ, ZEQ, ZGQ
Value Canada, US, EAFE ZVC, ZVU, ZVI
Dividend Canada, US, EAFE ZDV, ZDY/ZUD, ZDI/ZDH
Equal Weight Select Canadian and US Sectors Find in ETF Roadmap