Comatose European Stocks Turn Everything Into a Low-Vol Fund
(Bloomberg) -- The sudden tranquility in European stock market is starting to squeeze one of the selling points of low-volatility funds.
A gauge that seeks to isolate the region’s least-turbulent shares this week experienced more price swings than the broader market for the first time in almost 21 months, mirroring a recent trend in the U.S. Only twice before has the MSCI Europe Minimum Volatility Index been more volatile than the Stoxx Europe 600 Index, since Bloomberg began compiling the data almost 15 years ago.
While buying stocks aimed at shielding investors from market turbulence was a popular trade globally earlier this year, investors are getting no bang for their buck in Europe with placidity blanketing the entire market. They’re also paying up to own relatively expensive drugmaker and consumer-staple shares that are the biggest constituents of the MSCI gauge.
“It’s pretty challenging to find a subset of low-vol stocks when volatility for the broader market is this low,” said Christophe Edlinger, the London-based co-head of Alpha at BGC Partners, a brokerage firm. “The idea of these stocks being a proxy for safety can be a good one until a certain point, when the alternative then has to be bonds or cash. The past months show that taking a low-vol equity strategy can give you too much concentration risk.”
While expectations for price swings have spiked in Europe in recent weeks, realized volatility has decreased about 70 percent since a July high as central banks helped soothe panic following the Brexit vote. The MSCI gauge’s historic volatility rose above that of the Stoxx 600 on Monday, according to 20-day data compiled by Bloomberg. While the gap has since reversed, it’s still narrower than about 86 percent of the time in the past decade.
Investors flocked into low-swing trades earlier this year, pouring $8 billion into the most popular U.S. exchange-traded funds. The flows started unraveling in the second half of 2016, as improving economic data and expectations of a Federal Reserve rate increase pushed traders away from stocks deemed more immune to economic vagaries -- often ones owned by these ETFs.
The MSCI’s low-vol European gauge fell 3.8 percent since end-June through Thursday, versus a 0.5 percent gain in the Stoxx 600. Amundi SA and BlackRock Inc. are among firms that sell funds tracking the strategy in Europe.
Still, recent gains for the VStoxx Index measuring swings in euro-area shares show that traders are preparing for more turbulent times before next week’s U.S. elections, as well as votes in Italy, France and Germany later.
“There’s been a sustained increase in implied volatility,” said Adam Rudd, multi-asset investments director for Standard Life Investments in Edinburgh. His firm manages the equivalent of $335 billion. “Many catalysts are lined up.”
The index by MSCI Inc., which screens for firms that together generate the best returns with the least possible risk, is not the only one turning more volatile versus the Stoxx 600. The S&P Europe 350 Low Volatility Index, made up of 100 stocks that have shown the lowest individual swings, has also done so in October.
The top 10 constituents of MSCI’s low-volatility gauge, including Danone and Sonova Holding AG, trade at an average 18 times projected earnings, making them about a fifth more expensive than the Stoxx 600’s biggest stocks.
“It’s primarily a positioning shift,” said Patrick Moonen, a Hague-based strategist at NN Investment Partners, which manages $219 billion. “These stocks were a very crowded trade and when the rotation started -- driven by better macro data, commodity prices, Fed expectations and higher yields -- investors started to quit this type of stocks. It remains an open question whether global volatility will stay as low.”