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In equity investing, the secret to wealth creation often doesn’t lie in maximising returns when the market is booming, but in containing losses when it is going down the tube. So, wouldn’t it be nice to have an equity portfolio that is less volatile than the market, but delivers better returns in the long run?
Well, if this sounds impossible, it is the intent behind the NSE’s Nifty 100 Low Volatility 30 strategy index.
How it’s constructed
To construct the Nifty 100 Low Vol 30 index, index providers cherry-pick the 30 least volatile stocks from the top 100 names on the NSE. Volatility here is measured by the standard deviation of the stock’s returns in the last one year.
The 30 stocks with the least standard deviation make it to this club. Standard deviation is a statistical measure of how much a specific number in a time series differs from its average. Simply put, the Nifty 100 Low Vol 30 owns large-cap stocks whose prices have swung the least in the last one year.
Only stocks available for trading in futures and options and with a history of one year are considered. The weight of individual stocks is decided based on their low-volatility scores, too, with the least volatile ones bagging the most weights. This index is reviewed and rebalanced every quarter.
A more diversified basket
Thanks to its unique filter, the Nifty 100 Low Vol 30 index has a very different composition from its parent index, the Nifty 100.
One, it offers a more diversified spread compared with the Nifty 100. As on December 31, 2019, the top sectors in the Nifty Low Vol 30 were consumer goods (27.8 per cent), IT (17.2 per cent), auto (14.7 per cent), financial services (10.9 per cent) and energy (10.2 per cent). This contrasts with the whopping 40.5 per cent weight for financial services in the Nifty 100, followed by 13.2 per cent for energy, 12.8 per cent for consumer goods, 11 per cent for IT and so on. Given that financial stocks are fundamentally among the riskiest to own, the Nifty Low Vol 30’s low allocation to the sector reduces risks.
Two, its individual stock weights are lower, too. The top five weights in the Nifty Low 30 are Hindustan Unilever (4.3 per cent), HDFC Bank (4.2 per cent), ITC (3.9 per cent), PowerGrid (3.9 per cent) and Nestle (3.9 per cent). The Nifty 100 features HDFC Bank (9.5 per cent), Reliance Industries (8.4 per cent), HDFC (7.2 per cent), ICICI Bank (6 per cent) and Infosys (4.6 per cent).
Three, the filtering criteria for this index reduces volatility by weeding out stocks that have registered big moves recently, both on the upside and downside. For instance, the Nifty Low Vol 30 features slow movers such as PowerGrid, Cipla, Bajaj Auto and Wipro in its top 10, in the place of the Nifty 100’s Reliance Industries, HDFC, Infosys and Kotak Mahindra Bank. The latter have been prime movers behind the recent rally. This gives the Nifty Low Vol 30 a slightly contrarian flavour and makes for a less expensive portfolio.
As on December 31, 2019, the portfolio PE of the Nifty Low Vol 30 index was 22.8 times.
This is not exactly cheap, but is lower than the Nifty 100’s by 30.7 times.
How returns roll
Taking stock on January 16, 2020, the recent returns on the Nifty Low Vol 30 were decidedly inferior to those of its parent Nifty 100 on a total return basis. The trailing one- and two-year CAGR on the Low Vol 30 were at 9.1 per cent and 6.8 per cent, respectively, while the Nifty 100 sported 13.6 per cent and 7.2 per cent.
But, on a five-year basis, the Low Vol 30’s CAGR at 10.5 per cent was better than the Nifty 100’s 9.3 per cent.
Rather than point-to-point returns, though, rolling returns are a better test of the investment results any strategy delivers to its investors. On this count, the Nifty Low Vol 30 stacks up very well against the Nifty 100. Running a rolling return analysis over the last 10 years, the Nifty Low Vol 30 has delivered an average five-year CAGR of 16.5 per cent, superior to the Nifty 100’s 12.2 per cent.
Its worst show, at 9.99 per cent, again, comfortably beats the Nifty 100’s 0.5 per cent. Its best show, quite curiously, is better than its parent’s, too, at a 27.8 per cent versus the Nifty 100’s 24.4 per cent CAGR.
Its calendar year returns show that the Nifty Low Vol 30 lagged behind the Nifty 100 in bull years like 2007, 2017 and 2019, but made up by losing less in big bear years such as 2008 (it lost 42 per cent against 53 per cent on the Nifty 100) and 2011 (negative 12 per cent versus negative 25 per cent on the Nifty 100).
While this reaffirms the Low Vol 30’s loss-containing feature, 10 years is a short timeframe to assess the performance of any strategy, as it may cover just one market cycle.
Overall, the key pluses of the Nifty Low Vol 30 strategy are that it sticks to stable large-cap names in the market, while containing your losses by tempering down the momentum and concentration associated with indices such as the Nifty 100 and Nifty 50.
On the flip side, it uses no fundamental filters to select stocks, stays off momentum even if it is positive, and sticks only to the top 100 names, presently an overcrowded segment in the Indian market.
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