Low volatility index returns

Index providers have recently introduced indexes designed to capture the returns of low volatility stocks. Academic research, beginning with Haugen/Baker (1971, 1991, 2010) and continuing with other researchers, have posited the following advantages of holding low volatility stocks in both US and international markets:
 * Premium returns over market returns; higher risk adjusted returns;
 * Lower volatility of returns compared to market returns;
 * Lower drawdown losses than market returns during bear market declines.

Countering these advantages are potential drawbacks:


 * Tracking error to the market as low volatility stocks tend to underperform the market during strong bull markets;
 * Potentially higher turnover, and its attendant costs;
 * Sector diversification tilts, as low volatility stocks tend to have higher market weightings to utility, health, and consumer staple sectors.

For the the 1981-2011 period (see figure to the right), the volatility factor in the market was negative, with very high standard deviation; thus low volatility stocks (with low exposure to the volatility factor) provided premium returns over this period. Note that the index return histories below reflect this positive period.

Index returns
MSCI, Russell, and S&P provide minimum volatility and low volatility indexes covering both U.S. and international stock markets. The minimum volatility index seeks to lower volatility by using an optimization of variance minimization. The low volatility indexes employ a non-optimized approach based on historical volatities. A comparison of the two construction strategies is shown in the following figure:



The tables in the following sections provide index return, standard deviation, and growth of capital data. In addition, each low volatility index is compared to its parent index (for example, the S&P 500, Russell 1000, or MSCI EAFE indexes). MSCI introduced its minimum volatility indexes in 2008 with backdated data available going back to 2001. S&P began its low volatility indexes in 2011 with backdated data available going back to 1991. Russell introduced its indexes in 2011 with data backdated to 2002.

MSCI index returns
MSCI provides a wide ranging suite of minimum volatility indexes. MSCI currently calculates MSCI Minimum Volatility Indices for the following regions:
 * ACWI (All Country World Index)
 * Europe
 * EAFE
 * USA
 * Emerging Markets
 * World

According to MSCI, "the MSCI Minimum Volatility Indices are calculated by optimizing a parent MSCI Index by using an estimated security co-variance matrix to produce an index that has the lowest absolute volatility for a given set of constraints. The starting universe to determine a Minimum Volatility Index is an MSCI Equity Index and the estimated security co-variance matrix is based on the relevant Barra multi-factor equity model." The MSCI indexes are reconstituted semi-annually.

The tables below provide data for the MSCI indexes currently being tracked by investable exchange traded funds. Note that the international funds table includes tabs providing data for three MSCI international indexes tracked by iShares etfs.

S&P index returns
S&P provides a family of low volatility indexes which include US, regional, and international indexes. The indexes are rebalanced quarterly. The indexes rank and weigh the least volatile stocks in its respective index. The indexes are designed to hold:
 * S&P 500: the 100 least volatile stocks
 * S&P 400: the 80 least volatile stocks
 * S&P 600: the 120 least volatile stocks
 * S&P BMI Developed ex-US: the 200 least volatile stocks
 * S&P BMI Emerging: the 200 least volatile stocks
 * S&P Europe 350: the 100 least volatile stocks
 * S&P Pan Asia: the 50 least volatile stocks

In 2012 S&P also launched an optimized S&P 500 Minimum Volatility Index.

The tables below include data for the US indexes and the two currently investable international indexes: the developed market and emerging market indexes. Note that the US index table includes tabs for the S&P 500, S&P Mid Cap 400, and the S&P Small Cap 600 low volatility indexes, along with the S&P 500 Minimum Volatility Index. The international table includes tabs for the two S&P international indexes tracked by Powershares etfs.

Russell-Axioma index returns
Russell-Axioma low volatility indexes are constructed by ranking stocks by volatility. For U.S. indexes, the selection process starts with the lowest volatility stock, then a target portfolio is created by adding the next lowest volatility stocks until the target portfolio has a total capitalization of 35% of the Russell 1000 or Russell 2000 Index. This target portfolio is referred to as the “naïve factor index.” The Index then selects a portfolio of up to 200 stocks for the Russell 1000 Index or a portfolio of up to 400 stocks for the Russell 2000 Index. The indexes seek to "optimally track the returns of the target portfolio while managing turnover and neutralizing exposure to other factors, such as beta and momentum." The indexes are reconstituted monthly.

A similar index construction methodology is used in the Russell-Axioma Developed ex-US Large Cap Low Volatility Index. The index holds approximately 400 stocks of the Russell Developed ex-US Large Cap Index and is reconstituted monthly.

Currently, State Street provides an exchange traded fund that tracks the Russell 1000 low volatility index.

Comparative returns
The following tables provide comparative data for the low volatility indexes covering large cap US stocks, developed market international stocks, and emerging market stocks.

Investment options
Investors in the U.S. can invest in exchange traded funds based on MSCI minimum volatilty and S&P low volatility indexes. The table below provides a summary of available offerings.

Low volatility stocks tend to be dividend paying stocks. As a result, the dividend yields of low volatility index funds tend to be higher than the yield of market index funds. As a result, low volatility index funds are candidates for placement in tax-advantaged accounts.

Indexes

 * MSCI Global Minimum Volatility Indices
 * Russell-Axioma U.S. Large Cap Low Volatility Index
 * Russell-Axioma U.S. Small Cap Low Volatility Index
 * Russell-Axioma Developed ex-US Large Cap Low Volatility Index
 * S&P 500 Low Volatility Index
 * S&P Mid Cap 400 Low Volatility Index
 * S&P Small Cap 600 Low Volatility Index
 * S&P 500 Minimum Volatility Index
 * S&P BMI International Developed Low Volatility Index
 * S&P BMI Emerging Markets Low Volatility Index

Methodology

 * MSCI Minimum Volatility Indices Methodology
 * Russell Long-only Factor Indexes construction-methodology
 * S&P 500 Low Volatility Index, download methodology
 * S&P 500 Minimum Volatility Index, download methodology

Articles

 * Evaluating Alternate Beta Strategies, Xiaowei Kang, Journal of Indexes Europe, March/April 2012.
 * Factor Indexing, Barry Feldman and Gareth Parker, Journal of Indexes Europe, March/April 2012.
 * The Low Volatility Effect: A Comprehensive Look, S&P Dow Jones Indexes, August 2012.