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Is low vol flying too high?

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Insights and Market Perspectives

Is low vol flying too high?

Author: Abhishek Ashok

August 6, 2019

Low volatility has been one of the best-performing factors during the rally in equity markets this year, but that may not last given how significant low vol’s outperformance has been in relation to value, the most out-of-favour factor over the past six months.

While it may not be intuitive to pit the returns of low volatility and value against each other in the same way as investors regularly do for growth versus value, extreme divergences in the valuation of these two factors often signal important inflection points in the future performance of each.

At the height of the Great Financial Crisis in the fall of 2008, for example, the valuation spread between the lowest volatility stocks and the cheapest stocks (based on forward earnings) in the S&P 500 index was more than six standard deviations from its four-year average as investors fled to “risk-off” securities and shunned value stocks in the wake of enormous market uncertainty.

However, less than six months later in the spring of 2009, this same spread was back to less than one standard deviation away from its norm as value rallied relative to low vol.

Valuation spread between value and low volatility stocks

Source: AGFiQ with data from FactSet as of July 26, 2019. Valuation spreads are based on Z-scores calculated by subtracting the trailing four-year average from a given data point divided by the trailing four-year standard deviation.

A similar outcome was also true of the S&P/TSX Composite Index in Canada during that time frame and, on indices both sides of the border, there are several other instances in the past 20 years when larger deviations in the valuation spread between low vol and value have resulted in mean reversion shortly after.

Today, the valuation spread between these two factors has reached between two and four standard deviations away from the norm in the U.S. and Canada, respectively. Those are levels not seen in over a decade, suggesting value and/or higher volatility segments of the market may be due for an uptick in performance.

At the very least, investors should be cautious about their exposure to low volatility stocks going forward and maintain a multi-factor approach to prevent from getting caught too much offside.

Abhishek Ashok is an analyst at Highstreet Asset Management Inc. and a member of the AGFiQ quantitative investment team.

AGFiQ is a collaboration of investment professionals from Highstreet Asset Management Inc. (a Canadian registered portfolio manager) and AGF Investments LLC (formerly FFCM, LLC). This collaboration makes-up the quantitative investment team.

The commentaries contained herein are provided as a general source of information based on information available as of July 26, 2019 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

AGF Management Limited (“AGF”), a Canadian reporting issuer, is an independent firm composed of wholly owned globally diverse asset management firms. AGF’s investment management subsidiaries include AGF Investments Inc. (“AGFI”), AGF Investments America Inc. (“AGFA”), Highstreet Asset Management Inc. (“Highstreet”), AGF Investments LLC (formerly FFCM LLC) (“AGFUS”), AGF International Advisors Company Limited (“AGFIA”), AGF Asset Management (Asia) Limited (“AGF AM Asia”), Doherty & Associates Ltd. (“Doherty”) and Cypress Capital Management Ltd. (“CCM”). AGFI, Highstreet, Doherty and Cypress are registered as portfolio managers across various Canadian securities commissions, in addition to other Canadian registrations. AGFA and AGFUS are U.S. registered investment advisers. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. AGF investment management subsidiaries manage a variety of mandates composed of equity, fixed income and balanced assets.

™The ‘AGF’ logo is a trademark of AGF Management Limited and used under licence.

About AGF Management Limited

Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.

For further information, please visit AGF.com.

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Written by

Abhishek Ashok

Abhishek Ashok, M.A., MFE, CFA®

Analyst

AGF Investments Inc.

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