Rearranging Your Thoughts on Which Sectors are “Risky”

Earlier this year, everyone in investment universe seemed to be plowing money into funds and products marketing the low volatility anomaly. There were a host of new “low-vol” strategies launched and a handful of ETFs, all of them showing the decades-long superiority of low beta strategy. Those with a quantitative background immediately recognized what was really going on – it was just dividends and the value premium in drag – you see, low volatility sectors and stocks tend to have a lot of overlap with high-yielders and “cheaper” names.

Unfortunately, by adding low-vol index products to their portfolios, well-meaning advisors and investors were essentially chasing the most expensive, overbought stocks in the marketplace just as they were peaking out in valuation for the cycle.

Merrill’s chief of quant strategy, Savita Subramanian, looked at this phenomenon on Friday and notes that all of our notions of “risky” and “defensive” may need to be flipped upside down as the year draws to a close…

The changing risk profile for sectors
With this year’s equity returns being largely driven by sectors generally thought to
be lower beta areas of the market (Utilities, Staples and Telecom), our work
suggests that the definition of risk versus safety could dramatically change following
this year. Sectors that have grown higher beta, as measured by the biggest positive
discrepancy between 1-year and 5-year betas, are Telecom, Utilities and Consumer
Staples. On the flipside, some decidedly cyclical sectors like Financials, Materials
and Industrials have seen a collapse in betas using a 1-yr versus 5-year measure

change in beta

Josh here – So where is the true low beta investment to be had? It’s very interesting to see the materials stocks and banks and industrials declining in volatility relative to the supposedly stable sectors like telecom and utilities.

The market always keeps us guessing.


Bank of America Merrill Lynch

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