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Seeking a Smoother Ride
August 2013
Invesco PowerShares strategist Taylor Ames shares the recipe for creating
ETFs that aim to reduce unpredictability in an investor’s portfolio
As a senior equity product strategist at Invesco PowerShares,
Taylor Ames helps to cover PowerShares’ low-volatility
ETF lineup. Over the past three years, money has steadily
come into the firm’s S&P 500 Low Volatility ETF, which
has attracted more than $4 billion in assets since its 2011
launch. More recently, Standard & Poor’s used a similar
formula to create low-volatility indexes that specialize in a
smaller area of the market--mid-cap stocks, for example.
PowerShares then launched two low-volatility ETFs that
seek to track these indexes. Ames recently spoke with
Morgan Stanley Wealth Management’s Tara Kalwarski
about how the low-volatility indexes were created and where
they fit in an appropriate investors’ overall portfolio. The
following is an edited version of their conversation.
Tara Kalwarski: You work on strategy and research for 60
to 80 products. In today’s market environment, what are
investors looking for?
Taylor Ames: What’s been popular for the last couple of
years is this idea of low- volatility investing. The years 2008
to 2009 really changed the mindset of investors; mitigating
risk and trying to [manage risk] on the downside have
become paramount. We now have five different products
that are based on S&P low-volatility indexes.
Kalwarski: How do you determine which stocks are the
least volatile within a broad index like the S&P 500?
Ames: The S&P 500 Low Volatility Index, compiled by
Standard & Poor’s, starts with all of the stocks in the S&P
500 and looks at the standard deviation of each stock’s
volatility over the last year. The index then takes the 100
stocks that have exhibited the lowest volatility and weights
them [inversely to] their volatility: the lower the volatility,
the higher the percentage of the portfolio is allocated to the
equity. The index reruns that screen quarterly. That's the
entire methodology. There are no other constraints; the index
basically goes wherever volatility tells it to go. I think one of
the reasons these products have been so successful is
because of the simplicity of the methodology.
Kalwarski: Are there any common characteristics of the
100 stocks currently in the mix? Do certain sectors tend to
be more prevalent than others?
Ames: Right now the index has a pretty high allocation to
utilities and consumer staples. You typically get high-quality
companies that have dividends, so it’s not surprising that
those sectors would be well-represented. That said, while the
index happens to be heavily into utilities and consumer
staples now that may not always be the case.
Kalwarski: And what are the return expectations of these
types of low-volatility products?
Ames: Obviously we can't predict what [a product is] going
to do. But the idea here is that the product may not fall as far
when the markets sell off. Conversely, if the markets rally
heavily, we may experience some underperformance. That's
what the product seeks to do. Over time, you may potentially
outperform the broad market index because you mitigate
some of the losses.
Kalwarski: How does an ETF that seeks to track the lowvolatility index fit into a broadly diversified portfolio?
Ames: I think Financial Advisors are realizing that volatility
could be its own asset class. A lot of FAs are now using
these ETFs as a core asset class, meaning [a class of assets]
that they're always holding within their equity allocation as a
way to help build a stable foundation--similar to how they
always hold [ETFs that seek to track] the S&P 500.
And what Standard & Poor’s research has found is that lowvolatility investing [can] work across the board. In addition
to the S&P 500 Low Volatility ETF, we have one for mid
caps and small caps. And we also have developed
international and emerging-market low-volatility products.
Kalwarski: You mentioned that the U.S. product has a lot of
utilities. Are there any characteristics of the non-U.S. ETFs
that you think are worth noting?
Ames: It’s a very similar story across the board. If you own
one of these products, you’ll tend to invest in more defensive
sectors like consumer staples or utilities. But that’s not
always going to be the case. All of these portfolios track
indexes that have the ability to rotate in and out of sectors as
a reaction to market movement; on the international side
there’s the ability to respond to market movement by
rotating in and out of countries.
Kalwarski: What are the risks of investing in these ETFs?
Ames: [We’re] not using any sort of derivatives or anything
like that. Our ETFs track indexes that are made up of stocks
that are very widely held, known and traded, like the S&P
500. [One of] the [key] things that [suitable] investors need
to know is that if the market runs up--and runs up quickly-there is a pretty good chance that [they] may underperform.
[There may also be other investment risks associated with
the underlying securities in the ETF.]
Ames: We've seen inflows coming across in all types of
market environments. Since 2011 we've had times where the
market rallied pretty significantly, times when it pulled off
pretty significantly and times when it’s been flat. Yet our
inflows have been pretty consistent.
Kalwarski: What are the biggest challenges of maintaining
or marketing this type of product?
Ames: The ideas of low-volatility investing and lowvolatility indexes are fairly new. So we're still going through
an education phase with investors where we explain why
low-volatility investing [potentially] makes sense and why
the index performs as it does.
Kalwarski: Is there any market scenario that would require
out-of-quarter rebalancing?
Ames: In creating the index, S&P looked at a bunch of
methods. [It] considered an index of 50 to 250 stocks [and]
also looked at what would happen if the index were
rebalanced monthly or annually. And what S&P found is
that the quarterly rebalance was the best of all worlds.
You're able to rebalance pretty quickly but not so quickly
that you're catching false moves in volatility.
Kalwarski: So it's almost reflective of the age-old advice to
regularly rebalance your portfolio--but not too often or too
infrequently?
Ames: Exactly. We believe that over time, quarterly
rebalancing and an index of only 100 low-volatility stocks
will serve investors best.
Kalwarski: Do you think there are broader applications of
this type of strategy across other assets classes--fixed
income or commodities, for example?
Ames: We’ve created some strategies in the alternative
space, but it’s more of a low-correlation idea, not
specifically low volatility. We haven't seen anything in the
fixed- income or the commodities spaces as of yet, but that
certainly could be something that comes out in the future.
Kalwarski: The low-volatility products have seen
significant inflows since you launched in 2011. Do you think
this would slow if there were better signs of a sustained upmarket?
2
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