Equities Low Volatility: Is a vaccine a game changer for the market leadership?
23.11.2020
Low risk equity strategies have so far had a tough 2020. Global minimum volatility indices have underperformed a broad global market index by around 7-8 percentage points this year. The difference measured for similar indices in the US market is even greater – typically above 10 percentage points. The primary explanation for the difference in return is that the market leadership has been very concentrated this year. In other words, it has been very decisive for your return whether you have owned a few stocks included in the market index with a large weight. If you have not owned these stocks, it has been very difficult to match the market return. The so-called FANMAG stocks (Facebook, Apple, Netflix, Microsoft, Amazon and Google) have all had an impressive return this year with total returns in the level of 30% to 70%. The FANMAG stocks currently have an aggregate weight of approximately 12.5% in a global equity index (MSCI AC World), but has a very modest weight of less than 0.2% in a Minimum Volatility index (MSCI AC World Minimum Volatility). The absence of the FANMAG stocks in the Minimum Volatility index has thus had a very large negative effect on the index's return compared to the general market. The weight of the FANMAG stocks in the S&P 500 and MSCI USA is even higher – around 23% and 22% respectively – and this is probably the reason why the US minimum volatility index has had an even harder time matching the return of a broad US market index. For comparison the Equities Low Volatility strategy for the time being have an exposure against FANMAG stocks of around 2.8% – i.e. significantly lower than the a global equity index. Therefore, you can argue that Equities Low Volatility is a more balanced approach, as the strategy does not have the same high exposure against few potentially high correlated hot tech stocks.
Largest momentum/value rotation in recent times
The question is what does it take to change the narrow market leadership that we have witnessed this year? We got a taste of it on the day Pfizer announced positive test results for the company's covid-19 vaccine. The news suddenly increased the odds of some form of normalization of society in a not too distant future. This led to sharp share price increases for companies whose activities have been most negatively affected during covid-19 – i.e. airlines, cruise lines, travel agencies, companies in the entertainment industry and breweries. Conversely, stocks that have had tailwinds during the pandemic, including the FANMAG stocks, fell. The result was the largest momentum/value rotation in the stock market in recent times – stocks that had performed poorly this year increased in value, while stocks that had performed well declined in value. The rotation was not only a movement from defensive to cyclical stocks, but also a rotation within the individual sectors. Clorox and Asahi – both included in the consumer staples sector – are excellent examples of this. The US based company Clorox, which has benefited from increased demand for disinfectants during the covid-19 pandemic, fell by almost 11% on the day of Pfizer's vaccine news. Conversely, the Japanese brewery Asahi, which has experienced declining demand for beer and soft drinks away from home, increased by 10% on the expectation of a normalization of society after the emergence of a vaccine.
Equities Low Volatility managed the initial rotation well
Another obvious question is how the Equities Low Volatility strategy will perform versus the global equity market in an environment where value after several years of underperformance begins to outperform again at the expense of momentum and growth stocks. Based on the three days after the Pfizer vaccine news, there is reason for some optimism. The strategy generated a return of 3.94% measured in DKK over the three days compared to a return of 3.05% for the global equity market – i.e. an excess return of 0.90 percentage points. This may be surprising to some, as the strategy is overweight the stable and defensive companies and underweight cyclical companies, including banks as well as industrial and energy companies. A major part of the excess return is due to the fact, that the strategy has a significantly smaller exposure to the momentum factor and a significantly higher exposure to the value factor compared to the global equity market. Another explanation is that we have chosen to stick with some of the companies that have taken a hit during the covid-19 pandemic, even though it has been painful in the short term. Some of these stocks are breweries such as Asahi and Carlsberg as well as the off-price retailer TJX in the US. A continuing momentum/value rotation should therefore not necessarily be negative for the strategy – on the contrary, it could be a positive based on the initial experience. One thing is for sure though: we should not expect a straight line back towards a normalization of society – there will definitely be bumps along the way. This is the reason why we constantly aim to have a well-diversified portfolio of stable equities in Equities Low Volatility.