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Opus News & Insights

Low Vol and Dividends a Crowded Trade? Maybe, but Not Due to the Factors
Thursday, September 1, 2016

In the Monday August 22nd edition, the Wall Street Journal printed an article called, “Two Strategies, One Crowded Trade”. The article compares low-volatility strategies with dividend-yielding strategies and concludes there is substantial overlap. The article cites the presence of similar stocks in low-volatility and dividend ETFs and index funds as proof. The article then concludes that the success of the strategies has caused them to be expensive based on the P/E of the lowest beta stocks compared to the highest beta stocks.

Conventional wisdom would likely support these notions, given fund flows into Min Vol strategies and the continuing drop in interest rates. However, looking at the data, it is surprising to find that the overlap of the two strategies is likely much lower than expected and that high dividend yield may not be as expensive as low beta.

In a 10-year study of 1-year Beta and Dividend Yield for the total US market, we found diverging patterns in relative P/E. Low beta stocks were typically more expensive based on P/E than high beta and the market. The results do show the spread between the highest and lowest quintile beta group is historically high. However, when compared to the market, it appears that the spread between beta is mostly driven by high beta being cheaper than history rather than low beta being more expensive (Graph 1). The spread from Low Beta to the market at the end of July was actually cheaper than normal, though not by a significant amount.

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For Dividend Yield, the study showed that the portfolio of Low Dividend Yielding stocks typically had higher P/E than the market and that the High Dividend Yielding group is the lowest from a P/E perspective.  Looking at the historical spread from the market, the gap for the High Dividend Yielding portfolio has grown since 2014 (Graph 2), i.e., High Dividend Yielding stocks are cheaper today than they were in 2014 when compared to the market.

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Examining the equal weighted factor portfolio of the low beta results and the high dividend yield results shows large deviations. The two portfolios have tracking error of 5.8% between each other; a majority is due to factor risk tied to the higher yield, lower momentum, and higher volatility of the High Dividend Yield portfolio. The holding overlap of the two portfolios is very small as well with an active share of 89%.

The results of this analysis show that picking stocks using Low Beta and High Dividend Yield factors can lead to very different results. Well-designed and actively managed strategies are less likely to become crowded versus index strategies that rely on similar construction and screening tools. An alternative conclusion to the WSJ analysis is that factor-based indexes are the crowded trade, not the factors themselves.





 
 
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