Boring stocks are outperforming by most in two years

Bloomberg.- From trade tensions and missiles to election meddling and economic misses, a world awash in uncertainty is playing out in dizzying financial markets. For emerging-market and European equity investors unable to stomach tumultuous high fliers, sticking with the least-sexy stocks is paying off by the most in two years.

The strategy is one well observed by academics and often practiced by quants: Low volatility — sorting stocks based on the magnitude of price swings — tends to beat the market over time. The factor’s performance in the U.S. has lagged lately, but calm stocks elsewhere have picked up the slack.

That outperformance has caught the attention of a quantitative program at Gradient Investments LLC that powers one of its popular portfolios. This week, the $2 billion money manager pulled its funds from the PowerShares S&P Emerging Markets Momentum ETF and moved them into the low-volatility equivalent. That resulted in a record inflow of more than $420 million for the PowerShares S&P Emerging Markets Low Volatility ETF, according to data compiled by Bloomberg.

“Our strategy is quantitative, measuring momentum over different periods of time which is all proprietary,” said Mariann Montagne, a portfolio manager at Gradient Investments. “That computation put us into low vol.”

As nerves around the technology industry battered companies in China, emerging market low-volatility funds have benefited from being underweight the sector. A tilt away from Russian stocks also aided the funds after fresh sanctions against the country prompted a selloff.

Likewise, the iShares MSCI Min Vol Emerging Markets ETF has outperformed the plain vanilla emerging-markets ETF by 4.3 percentage points over the past 30 days, the largest spread over such a stretch since February 2016. So far this week, min vol has gained 2.3 percent versus 2.1 percent for the broader market.

In Europe, the risk-on rally over the past two years has depressed prices of low-volatility shares to the cheapest in a decade compared to their high-volatility counterparts, according to equity strategists at UBS Group AG headed by Karen Olney. Since low volatility is a key criteria for defining quality, and economic data keeps surprising to the downside, the stocks look like an attractive buy, they said.

Over the past month, the iShares MSCI Eurozone ETF has fallen 0.4 percent, compared to a 0.2 percent gain for the iShares MSCI Min Vol Europe ETF.

American low-volatility funds haven’t been so lucky. The strategies have binged on bond proxies like utility and consumer-staple companies — a losing bet as the Federal Reserve charts its path to higher interest rates.

“Most low vol utilized an overweight in interest-sensitive sectors, which therefore may not do as needed, when needed,” said James Pillow, managing director at Moors & Cabot Inc. “Instead, it may exacerbate their downside momentum if interest rates continue to trend upward.”

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