The Whaley Report: Chasing trucks

Whaley Report

Growing up, I had a cockapoo dog named “Midnite” who hated the UPS man with a passion. Not even two pepper spray incidents could dilute his disdain. One day, as the UPS man was driving by the house, Midnite knocked open the front screen door and chased after him. The UPS man slammed on the brakes and Midnite ran full speed into the side of the truck, getting knocked back about 15 feet.

Like Midnite chasing the truck, investors chase the shiniest new strategies or the markets with the best returns hoping to find the Holy Grail of investing: great returns and no downside. The problem is that rather than finding Madoff-like returns without the Ponzi scheme, they run full speed into the side of a truck that knocks their account value back 15 feet. Right now, investors are chasing the USMV and XLE trucks without realizing that the brakes are about to be slammed.

One component of behavioral gravity that I watch is the fund flows of exchange traded funds (ETF). While I was reviewing the latest fund flow data, something startling jumped out at me. The fund flows into “low volatility” strategies have been epic this year. Some of these strategies promise low volatility no matter what world markets are doing, and others promise to match the performance of a benchmark without the normal level of volatility. Sounds perfect, right?

The largest of these funds is the iShares Edge MSCI Min Vol USA ETF: USMV, which attempts to mirror the return of the S&P 500 but with lower volatility. USMV has been around for five years, but almost half of its $13B in assets came in this year. This raised a red flag, and when I dug a little deeper I realized that these strategies are heavy on marketing magic and light on execution.

The stated objective of the USMV ETF is to track the results of the S&P 500 with “…lower volatility characteristics.” From a statistical perspective, the fund delivers, but barely. The annual volatility for USMV is 10.0%, versus 11.9% for SPY. It’s almost impossible to tell the difference between the monthly returns of an investment with annual volatility of 10% versus one with volatility of 12%. Not to mention you’re paying almost twice as much in management fees to invest in “low vol” as you are in SPY.

When I evaluated the returns, I realized that the USMV truck is closer than it appears. Over time frames from as short as a week to as long as five years, USMV underperforms SPY anywhere from 100 to 500 basis points. But it’s not just the overall underperformance that’s a head scratcher; it’s the timing that is most shocking.

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