Exploiting The Yield Chasers

Last Updated: 16 April 2024

A chart sent to me by Charles Morris, head  of absolute return at HSBC Global Asset Management, indicates why low-volatility index strategies are generating such interest from investors.

Note the total return of S&P’s  low-volatility index since 1990 in the chart below (white line), compared with what one might call low-vol’s mirror image, high beta (the S&P high beta index’s total return is shown in the red line).

Despite suffering a period of significant underperformance against high beta in the 1990s and again in 2003 and 2009, low-vol has returned over half as much again as high beta on a 22-year view (over 900% for low-vol, versus 600% for high beta).

[For a detailed, year by year review of the relative performance of volatility as a “factor”, see Xiaowei Kang’s article from the March/April 2012 Journal of  Indexes Europe].

But although high-beta stocks did better than their low-vol counterparts during the initial recovery from the bear  market low of March 2009, since then they’ve stagnated, while low-vol equities have gone on a tear.

The reason for the remarkable recent  performance of low-vol equities is that these stocks typically pay high dividends, and investors have been snapping them up in tandem with any other asset class that can offer enhanced income in the current environment of near-zero rates (preferred stocks, high yield and emerging market bonds, real estate are other fund categories that have also seen substantial investor inflows).

“The dash for yield is a dash for calm,” says Charles Morris. Preoccupied by safety and protecting against downside risk, investors are all chasing the same names.

Here, the ears of any investor with a contrarian bent should be pricking up. And there’s double reason to doubt the sustainability of the yield-chasing trend. Any decent financial history will  tell you that chasing income in a low-yield environment is one of the riskiest  strategies you can pursue. We’ve seen regulators shift uneasily in their seats this year as they realise they may be sowing the seeds of the next large-scale investment accident by keeping interest rates so low.

“Given the low yields on Treasuries, we are concerned that investors may be inadvertently taking risks that they do not understand or that are inadequately disclosed as they chase yields,” US regulator FINRA said earlier this year in a letter to advisors. The UK’s FSA, apparently worried about the scale of retail  buying of funds investing in corporate debt, a notoriously illiquid asset class, asked fund management firms this summer to ensure they could cope with  large-scale withdrawals.

So is it time to take a contrarian view by switching from low-vol to high beta, or by shorting the former and buying the latter in a relative value trade? Possibly, but there may be an even better way of exploiting the recent yield-chasing trend.

HSBC’s Morris says he still loves gold (I own it in my pension plan too). Paradoxically, given that commodities produce no income, gold may still be the smartest way of protecting oneself against central banks’ policy of financial repression.

Author
  • Luke Handt

    Luke Handt is a seasoned cryptocurrency investor and advisor with over 7 years of experience in the blockchain and digital asset space. His passion for crypto began while studying computer science and economics at Stanford University in the early 2010s.

    Since 2016, Luke has been an active cryptocurrency trader, strategically investing in major coins as well as up-and-coming altcoins. He is knowledgeable about advanced crypto trading strategies, market analysis, and the nuances of blockchain protocols.

    In addition to managing his own crypto portfolio, Luke shares his expertise with others as a crypto writer and analyst for leading finance publications. He enjoys educating retail traders about digital assets and is a sought-after voice at fintech conferences worldwide.

    When he's not glued to price charts or researching promising new projects, Luke enjoys surfing, travel, and fine wine. He currently resides in Newport Beach, California where he continues to follow crypto markets closely and connect with other industry leaders.

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