A fallen star of the investment world

Blow for investors as popular ‘minimum volatility’ funds stumble

Robin Wigglesworth

Wells Fargo had initially planned to name its ‘mini-vol’ investment vehicle the Stagecoach Fund to reflect its history © Allen Creative/Alamy

When Wells Fargo hired Fischer Black and Myron Scholes in the late 1960s to advise on its plans for the first-ever index fund, the economists made a curious discovery. 

The internal argument they triggered still echoes in the investment industry today.

Back then, it was the heyday of Eugene Fama’s “efficient markets hypothesis”. 

This stipulated that the stock market was in practice unbeatable, as all new relevant information was continually baked into prices. 

But professors Scholes and Black found that one could outperform by simply buying stocks with lower volatility, possibly because investors systematically overpaid for more exciting, choppier securities.

This was radical. 

Such a free lunch — getting both greater and steadier returns — contradicted economic dogma at the time, which dictated that one could only generate greater returns by taking on greater risks. 

But the data was the data, so Black and Scholes suggested that Wells Fargo set up a passive fund that would take advantage of this apparent anomaly. 

Ultimately, what was going to be named the Stagecoach Fund — a homage to Wells Fargo’s storied past — foundered. 

The bank instead eventually pivoted to a simpler S&P 500 index fund. 

But the core idea lives on in what is often called “minimum volatility” strategies. Today this is a nearly $90bn corner of the exchange-traded fund industry.

Unfortunately, they have not lived up to expectations lately. 

The min-vol “factor” — as these investment signals are usually termed — is now the worst-performing of all the mainstream ones over the past year, after cheap value stocks and smaller shares enjoyed a renaissance. 

This year, min-vol has done worse than even once-hot momentum stocks, which have been trashed in the recent violent equity market rotation caused by investors betting on a post-Covid old-economy boom.

Take BlackRock’s $28bn min-vol ETF, the biggest in the field and a good proxy for how well the broader investment strategy is doing. 

Since the beginning of 2020 it is up about 4 per cent. 

The second-worst factor over that time is value, which is now up nearly 15 per cent after a powerful bounce since last autumn. 

MSCI’s broader US stock market index has climbed almost 25 per cent over the same period. 

This is not an isolated issue, nor uniquely a US equity market phenomenon. 

BlackRock’s European, global and emerging-market equivalents have all markedly underperformed their respective broader benchmarks. 

Although the ETFs have largely done their job in being steadier than the broader market lately, their volatility is only marginally lower. 

And that will be of little consolation to investors who have now somehow missed out on one of the most powerful 12-month periods for stock market returns in history. 

Worse for the argument that low-volatility stocks should at least in the long run deliver above-market returns, the biggest min-vol ETFs have now all underperformed their conventional benchmarks over the past decade, in some cases sharply so. 

What has caused once-popular investment factor to fizzle so badly, and can it enjoy a belated blossoming?

History holds some lessons in this respect: One of the reasons why Wells Fargo never followed through on the original idea proposed by professors Black and Scholes back in the late 1960s was that Bill Fouse, one of its senior executives at the time and a pioneering quant in his own right, argued that simply buying low-volatility stocks would erode the benefits of diversification: Steadier securities tend to be found in certain stable industries. 

In short, he applied some common sense to what the data indicated. 

It proved a fortuitous decision. If Wells Fargo had launched a leveraged, low-volatility passive fund at the time it would likely have imploded in the 1974 bear market, and might have set passive investing back by years.

Nowadays, most factor strategies strive to be somewhat sector-neutral. 

In other words, they try to avoid herding into just a few industries, stay somewhat diversified and not diverge too far from the overall make-up of the stock market. 

But in practice min-vol strategies do tend to lean heavily into some specific corners of the market, such as healthcare, consumer staples and utilities, which have underperformed lately.

However, the broader more intractable problem may simply be that the min-vol anomaly first identified by Scholes and Black — greater and steadier returns — was simply too much of a free lunch to last for ever, and has now gone the way of the dodo. 

America’s upper-arms race

Americans are rushing to get vaccinated as covid-19 cases spread

The supply of vaccine soon won’t be a constraint

What’s the most fun to be had in Roscoe, a suburban village in northern Illinois, after dark on Friday? 

Judging by the happy chatter of those queuing between racks of suntan lotion in a Walgreens chemist last week, nothing beats an appointment for a covid vaccine. 

They were welcomed by a pair of efficient pharmacists who dashed off paperwork, then gave injections behind a screen on the shop floor. 

At the evening’s end a vial with a single dose of Moderna vaccine lay unused. 

To avoid waste, the pharmacist stuck it in your grateful correspondent’s left arm.

If Roscoe’s residents didn’t have sore muscles, they might like to pinch themselves. 

Their country has powered ahead of almost every other sizeable one (Britain excepted) in rolling out vaccinations. 

Winnebago county, home to Roscoe, is typical. 

Like America, by March 30th 16% of its residents were fully vaccinated. 

Across the state 30% have had at least a single jab, also not far from America’s average.

That’s a remarkable achievement. 

The pace of injections surged in recent months as supply rose (vaccines by Johnson & Johnson, Moderna and Pfizer are all in use; one from AstraZeneca may soon be approved). 

An average of 1.3m doses went into arms daily at the end of January. 

By this week it was 2.8m, and rising.

States are relaxing rules on who gets protection. 

By the end of March, 16 of them said adults of any age may sign up for jabs. 

Another 22—including California, Illinois and New York—will do so in April. 

By mid-April, says Joe Biden, 90% of adults will qualify. 

By early May, over half of adults should be at least part-vaccinated. 

Mr Biden’s promise in January, of 100m vaccinations in his first 100 days, is long out of date. 

Twice that tally is doable.

Who gets the credit? 

The previous administration of Donald Trump is owed some. 

It bet on tackling the pandemic with quick production of vaccines, using federal funds to subsidise drugmakers. 

Yet for weeks he failed to announce he’d had the jab in January, which is one reason why his followers (especially white, Republican men) are the least eager to sign up for protection. 

One hopeful survey, this week, did suggest vaccine hesitancy is falling.

A poll by Ipsos this week found that a whopping 75% of Americans approve of Mr Biden’s handling of the vaccine roll-out, and almost as many like his leadership on the pandemic overall. 

Optimism is spreading that vaccinations will allow schools, offices, bars and restaurants everywhere to open again as normal before long.

Changes in behaviour caused by that optimism, however, are now a concern. 

A big increase in passengers at airports and guests at hotels, along with a decision by some states (including Iowa, Mississippi and Texas) to scrap rules on wearing masks, have created conditions for cases again to rise. 

In some states, such as Michigan, a new spike in cases is evident.

Mr Biden asked governors on March 29th to reinstate those mask rules. 

The head of the Centres for Disease Control, Rochelle Walensky, on the same day spoke of a “recurring feeling I have of impending doom”, given the trends she saw. 

Cases are rising especially among the young. 

In Roscoe, the rolling covid positivity rate ticked up in late March. 

A more infectious and deadly variant of the virus, B.1.1.7, first found in Britain, is also becoming common. 

Other variants pose threats.

A race is thus on. 

Even faster vaccination is coming, as Mr Biden vows that 90% of the population will live within five miles of the nearest vaccination centre. 

The supply of vaccine soon won’t be a constraint. 

Instead the challenge will be to convince those not already keen to flock to a pharmacy late on Friday night of the benefits that flow from a shot in the arm.

Central Banks’ Taper Dilemma

Central banks are clearly not responsible for today’s investment decisions, but the longer their market support continues, the riskier the search for yield may become. Monetary policymakers and credit investors alike are facing an unenviable dilemma.

Patrick Drury Byrne, Sylvain Broyer

DUBLIN – Central banks’ unconventional policies undoubtedly rescued financial markets in 2020 when the COVID-19 pandemic was at its height. 

But those actions now leave central banks joined at the hip with credit markets, and market participants more reliant than ever on their support.

From a credit-market perspective, this represents a Catch-22 for both central banks and investors. 

How can central banks continue to support the economic recovery while developing an exit strategy that doesn’t undermine market stability? 

And how will investors, who prize stability but also seek higher yields, react if and when monetary policymakers step back from providing direct market support?

With low interest rates for most of the past decade, it was clear from the start of the COVID-19 crisis that central banks had little room for maneuver with conventional policy tools. 

They would have to lean even more heavily on unconventional measures, including initiating or extending corporate asset-purchase programs. 

In the case of the US Federal Reserve, the announcement of these measures during 2020 coincided with investment-grade corporate bonds’ peak spread.

“Coincided” is the key word here. 

It is not clear whether these actions mean that conventional tools are now less effective in restoring market confidence in times of stress, or whether the pandemic’s idiosyncratic nature required a precision strike of support to the particularly vulnerable corporate sector.

The widespread use of asset-purchase programs could simply have been the last in a long line of measures that finally brought market stress under control. 

Or it could represent a recalibration of how active and forceful central banks need to be in a crisis. 

At the very least, the new precedent in terms of market expectations that their extreme actions have set will be difficult to ignore in periods of stress in the future.

Central banks’ actions, alongside governments’ unprecedented fiscal support, restored financial stability in 2020. 

They also indirectly fueled record corporate bond issuance and a 60% drop in investment-grade corporate bond spreads from their March highs.

This restoration of stability was hard won, requiring extensive quantitative easing (QE) and new or extended interventions, particularly in corporate credit markets. 

Through a combination of rate setting, financing, and widespread QE, central banks now play a more pivotal role than in the past.

But what is their long-term plan? 

Central banks could maintain QE, as the Fed has suggested and the European Central Bank has done in the past, but protracted QE can be difficult to unwind and could keep interest rates lower than they might otherwise be. 

Alternatively, they can seek to dial back QE, which would require a delicate balance and clear communication to avoid unnerving market participants still mindful of the 2013 “taper tantrum,” a selloff triggered by signals from the Fed that it would reduce monthly asset purchases.

The task facing monetary policymakers is further complicated by the continued need to support the economic recovery. 

Global debt was forecast to peak at 267% of GDP at the end of 2020 and is set to remain elevated as governments continue issuing debt to fund critical recovery measures. 

Central banks have been a cornerstone investor in many transactions, providing governments and (to a lesser degree) corporate firms with the certainty of low-cost financing.

Because central banks’ sovereign-debt purchases are unlikely to change in the medium term, their holdings will increase further. 

In Europe, the stock of long-term government bonds outstanding has increased by about 25% since 2015 but the free float, or publicly tradable portion, has fallen, owing to the sharp increase in the ECB’s bond holdings.

Although the ECB will not suddenly start to divest its substantial portfolio and send prices downward, concentrated bond ownership could negatively affect market structure and liquidity. 

This is already evident in the European covered bond market, where the ECB now holds about one-third of all eligible bonds outstanding. 

A lower market free float could reduce the number of active investors, increase volatility, and reduce price discovery in future periods of stress. 

Consequently, a true picture of liquidity and financing conditions in certain markets will probably emerge only if and when central banks start to scale back their portfolios.

Global investors have benefited from central banks’ stabilization of credit markets, and there have been fewer pandemic-related defaults to date than many participants initially feared. 

But low interest rates and sustained monetary stimulus have made it difficult for fixed-income investors to generate target returns, with approximately 90% of global bonds trading at a yield below 2% at the end of 2020. 

Recent yield-curve steepening has provided some respite, but central banks’ support remains critical to the global economic recovery – and the longer it remains in place, the more it may imperil fixed-income returns.

Lower fixed-income returns have obvious consequences for pension funds and future retirees, while investors are also chasing higher yields by taking on new and longer-duration risks, or increased credit risks, which ultimately could destabilize the system that central banks worked so hard to bolster. 

Leveraged loan issuance by B-minus rated borrowers has risen to a record high, according to a February report by S&P Global Market Intelligence, while borrowing costs have fallen to their lowest point since the 2008 global financial crisis.

Central banks are clearly not responsible for today’s investment decisions, but the longer their market support continues, the riskier the search for yield may become. 

Monetary policymakers and credit investors alike are facing an unenviable dilemma.

Patrick Drury Byrne is Senior Director and Cross-Practice Sector Lead at ‎S&P Global Ratings.

Sylvain Broyer is Chief EMEA Economist at S&P Global Ratings. 

Russia, China and the United States: First Shots

By: George Friedman

Any time there is a new U.S. president, major powers set out to test him and lay the groundwork for future bargaining in potential conflicts. 

Occasionally, the United States opens the bidding. Such was the case when Washington, through its new secretary of state, Antony Blinken, accused Beijing of human rights violations in Xinjiang and Hong Kong and of various cybercrimes. 

Beijing responded by calling Washington an enormous human rights violator, adding that it does not speak for the world and should not claim to. 

This is the tone for a showdown, not for a pleasant introduction.

All this took place ahead of a meeting that was doomed to fail. 

Before the meeting could take place, Blinken and Jake Sullivan, the U.S. national security adviser, spent time in South Korea and Japan, both of which oppose China and, despite being longtime allies, have specific gripes with the U.S. (Seoul over the cost of hosting U.S. troops and Tokyo over enhancing its military to face China.) 

Both meetings went well. 

Elsewhere, talks were held with the Quad, a security dialogue comprising the U.S., Japan, Australia and India, all of which are naval powers hostile to China. 

In other words, the U.S. held a series of meetings with its anti-China allies just before it met with China.

As the talks were in the process of collapsing, President Joe Biden was asked in an interview whether Russian President Vladimir Putin was a killer. 

He said he was. 

It’s not something you normally say about the head of a major power, even if it’s true. 

Biden had plenty of time to recant his statement had he wanted to, but he didn’t. 

The Russians were upset and recalled their ambassador. 

Putin essentially said, “it takes one to know one.”

I see this as Biden beating China and Russia to the punch. 

He and his team wanted to let them know – and, indirectly, let the American public know – that he’s not going to be a weak president. 

Russia’s and China’s responses, of course, were meant for the United States – as well as for U.S. allies who might doubt its strength.

In diplomacy, talk is cheap, and opening acts such as these matter little. 

Some have said it sets the tone for the next four years, but it doesn’t. 

It sets the stage for the first month, after which everyone, having the opportunity to sniff and growl at each other, settle into reality. And reality militates against drastic action. 

The U.S. is China’s biggest customer, which Beijing cannot afford to lose. 

It is much easier to acquire needed goods in other markets than to sell in other markets. 

As for Russia, it could pick a fight in, say, Ukraine or Moldova, but doing so would create its worst-case scenario: NATO, Germany and other countries amassing forces in Eastern Europe. 

So let’s rule that out too.

Russia’s and China’s options are obviously more complicated than what I lay out here, but they are also hemmed in by these realities. 

The meetings held by the U.S. prior to the meeting with China were meant to remind the Chinese of as much, that it should not overestimate its strength or underestimate its strategic isolation. 

Calling Putin a killer was meant to warn Putin against covert operations, and to let him know that Washington knows how weak Russia is and doesn’t care what Russia thinks.

The risk is that Biden is wrong and that Russia and China are not as weak as he thinks. 

In my view, they are in no position to challenge the United States or attempt military action. But it is one thing to write and another to bear the burden of action. 

The question is what sort of action the Russians and Chinese might take. 

The logical solution is to form an alliance. 

The question is what it would look like and whether it would matter.

An economic alliance would be ineffective. 

Russia and China trade with each other without friction. 

Neither would have a sufficient market to support the other’s needs. 

There is a symmetry in that Russia needs Chinese consumer technology and China needs Russian raw materials, but each is already getting what it needs and providing what it can manage. 

An economic alliance would perhaps formalize existing relations and perhaps increase trade but would not make either invulnerable to third-party pressures.

A military alliance is similarly problematic. 

Neither Russia nor China can support the other’s strategic needs. 

The primary threat to China is naval. Russia’s naval capacity is limited, and its major Asian port, Vladivostok, requires passage through maritime routes that are controlled by Japan and the United States. 

Russia would be contained by the same coalition threatening China. 

The threats to Russia are primarily terrestrial. 

China’s ability to send forces to areas of Russian concern is limited, and Russia has no pressing need for additional ground troops. 

There are areas in which one could help the other, such as military hardware or cyberwarfare, but that isn’t a real alliance.

Could a Russo-Chinese alliance launch a naval assault in the east and a ground attack in the west simultaneously? 


But doing so, while politically shocking, would not weaken either front because it would be engaging naval forces not needed in the west and ground forces not needed in the east. 

It may also fail If it succeeded, it would trigger existential (nuclear) choices or create unshakeable anti-Russia and anti-China alliances.

The more logical and less risky move is for China to reach a political and economic agreement with the United States, and for Russia to do the same, at least with Europe. 

But to do this, each must be convinced that the U.S. is not interested in a settlement. 

Showing a lack of interest is the foundation of any bargaining position. 

The best read is that the U.S. knows that bargaining is coming and is therefore posing as hostile to it. 

The Chinese have called the Americans’ bet. 

The Russians shortly will. 

At any rate now is the time for insults and threats, before we get down to business that may fail regardless of all this.