ETF issuer Ossiam has added to its range of ETFs seeking to reduce share volatility with the listing on the London Stock Exchange of a FTSE 100 minimum variance ETF. The fund and the index underlying it are the first of their type.
Last year Ossiam launched its ETF range with the introduction of minimum variance funds on European and US share indices, together with funds that equally weight European and Eurozone shares.
There has been growing investor interest in low-volatility strategies, with the US-listed Powershares S&P 500 Low Volatility Fund gaining over US$1 billion in assets since its launch in May last year. Minimum variance indices, such as those tracked by Ossiam’s funds, are closely related to low volatility indices of the type used by Powershares, and have similar objectives. Both types of index aim to reduce the overall volatility of the investment portfolio. There is a difference, however, in the way the indices are put together.
Minimum variance indices use an optimisation algorithm to select portfolio stocks and weight them according to their historical volatility and their correlations with each other, typically subject to some constraints for individual sector and stock weightings and for overall portfolio diversification. Low volatility indices are simpler in construction, typically using a non-optimised approach to select those stocks that have been least volatile historically, and then weighting them accordingly.
For its new FTSE 100 fund, Ossiam is using physical replication with no securities lending, by contrast with its existing minimum variance ETFs on European and US shares, which are synthetic (swap-based). The decision to use physical replication, said Isabelle Bourcier, Ossiam’s head of business development, was as a result of investor preference for this format. Ossiam remains agnostic, she said, about different replication methodologies and may use either in future. Bruno Poulin, Ossiam’s CEO, said that the issuer had chosen not to lend out securities as it felt that the potential extra revenues did not justify the additional risks for fund investors.
The FTSE 100 minimum variance ETF also comes with a reduced expense ratio—0.45% per annum—than the Ossiam Minimum Variance ETF and the Ossiam ETF US Minimum Variance, both of which charge 0.65% per annum.
The choice of physical replication for the UK minimum variance fund implies that there will be some drag on returns as a result of the 0.5% stamp duty payable on purchases of UK shares. Ossiam says that historical annual turnover for the UK minimum variance fund, whose underlying index is rebalanced quarterly, has been around 100%, implying stamp duty-related costs of around 0.25% a year. The iStoxx minimum variance and S&P 500 minimum variance indices tracked by Ossiam’s other two funds of this type both rebalance monthly, generating higher annual turnover of around 400%, says the issuer.
The use of an optimisation algorithm to minimise the volatility of FTSE 100 stocks has a significant effect on sector and stock weightings within the index. According to figures supplied by Ossiam, after the optimisation there are significant reductions in the unconstrained FTSE 100 index’s sector weightings for oil and gas stocks (from 21% to 5%), basic materials (from 12% to 3%) and financials (from 16% to 10%), while consumer services stocks are boosted from 9% to 20%, industrials are boosted from 5% to 16% and utilities rise from 4% to 15%.
Over the last ten years a minimum variance approach would have benefited investors handsomely, says Ossiam. A back-test of the FTSE 100 minimum variance index produced an average annual return of 9.3% a year, says the firm, with annualised volatility of 16%. By contrast the unconstrained FTSE 100 index has returned 4.2% a year over the same period, with higher volatility, 21%, reports the issuer.