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Low-volatility trading strategy continues winning streak in 3rd quarter

Traders following a strategy of investing in low-volatility stocks beat all comers for the third time in the past four quarters as a turbulent economic and trade background spurred demand for the sanctuary of companies perceived as less risky.

The S&P 500 Low Volatility index returned 5.1% in the third quarter, ahead of Dividend Aristocrats (3.1%) and Value (2.2%), an unusual outcome as typically, the low-volatility index does not outperform significantly when the overall market gains. The High Beta index, which includes stocks most sensitive to market changes, performed the worst in the third quarter, shedding 3.3%.

The S&P 500 was stable around record levels in July and September, on either side of a turbulent August, and ended the quarter up just 1.2%.

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"Low volatility strategies with their ability to limit downside exposure while catching most of the upside have continued to outperform in the past quarter," said Chris Bennett, director of Index Investment Strategy at S&P Dow Jones Indices. "Because it is unconstrained from a sector point of view, [the index] has been able to take on big holdings of real estate and utilities in the past year."

This lack of sector constraints has aided the low-volatility portfolio to outperform the "otherwise thematically similar, but sector constrained" Minimum Volatility index by 10% over the past 12 months, S&P Dow Jones Indices data shows.

The Low Volatility index was also the best performer in the second quarter of 2019 and the final quarter of 2018. It outperformed all other S&P 500 factor indexes over the first nine months of this year, increasing by 23.8%, ahead of Momentum (19.8%) and Quality (19.7%), while the Enhanced Value index was the worst performer, with a 10.8% gain.

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"In an environment of slowing profit growth, we believe investors should maintain a defensive high quality bias, and the recent factor volatility offers investors the opportunity to add to that position, in our view," Wesley Chan, Yang Lu and Bill Smith of Pacific Investment Management Co. wrote in a research note.

While the overlying S&P 500 index is relatively calm, there is "rising dispersion and volatility of factor returns" as investors, wary of an economic slump, start to pick "winners and losers," the fund managers said.

Despite maintaining a cautious approach, Pacific Investment Management suggested this increased turbulence could present opportunities as a panicky market undervalues certain stocks.