The iShares Edge MSCI Min Vol USA ETF (USMV) and iShares Edge MSCI Min Vol Global ETF (ACWV) have been building impressive track records since they were launched in 2011. With average annual returns similar to their respective parent indices at around 10% per year, but with roughly half the return volatility, both have largely delivered on their promise of stability.
The trade-off? Half the time these ETFs have underperformed the broader market by 6% per year or more. For investors, then, the difference between being flat or up over the life of the investment and – far less attractive – being flat or down may be as simple as buying at the right time.
Our question: Is now one of those times? We turned to holdings-based analytics specialist Windfactor Research for insight.
President, Windfactor Investment Research
Our data suggests that now may indeed be a good time. The current Windfactor for USMV is 71, suggesting better than 2:1 odds that this year’s fund returns will be above our US market benchmark. The last time the fund was similarly positioned was at the start of 2013, when we saw a respectable 2.5% of excess returns for the ETF. And while we don’t currently calculate Windfactors for global equities, the high correlation of returns for USMV and ACWV with their respective broad-market indices (see Figure 1) suggests a similar outlook for ACWV today.
How they work
By design, these funds lag during market rallies but outperform during downturns. According to MSCI’s literature, the underlying indices track the portfolio of stocks with the lowest possible total variance, as determined by MSCI’s equity risk models, without sacrificing the benefits of diversification across single stocks, sectors and (if applicable) countries and currencies. They hold stocks with smaller market capitalization that have historically seen relatively stable market value, with small tilts toward lower volatility sectors such as utilities.
Figure 2 shows the underlying drivers for USMV’s current Windfactor (see Windfactor ABCs). The fund’s best-match average historical return of 1.7% is driven primarily by overweights to characteristics such as above-average earnings and book value, in addition to the strategy’s stated tilt toward smaller firms. The fund’s overweight to firm-specific factors serves to lower volatility around the average to an even 3%, implying that portfolios of stocks similar to USMV’s current holdings historically outperformed the broad US market in 71% of best-match historical periods.
Do Windfactors work?
As with other quantitative tools, using Windfactors and best-match returns to forecast next year’s performance is a bet that history will repeat itself. This is hardly certain for equities, where new things can happen at any time and past return patterns can break with lasting changes to business fundamentals. However, the monthly IC for USMV since launch is above 0.10, indicating that USMV has consistently, if not always, performed in line with the past.
What they are:
The statistical probability (0 – 100) that a fund will outperform the US market over the next 12 months given past market conditions.
How they’re built:
The historical risk-adjusted returns of similar companies with similar starting prices, as calculated by Windfactor’s unique business factor models. These best-match returns are reported in percentages relative to the broad US market.
Why we care:
Windfactors predict actual fund returns whenever history repeats itself. Research suggests that systematically investing in funds with higher Windfactors would have been a good bet over the past decade.