Should you invest in low-volatility funds amid high market volatility?

Low-volatility funds aim to reduce the impact of market volatility by investing in a basket of stocks that tend to be less volatile. These are passive funds that track low-volatile indices. The funds invest in stocks included in a low-volatility index, which picks stocks on the basis of volatility scores rather than business fundamentals. Volatility is calculated as the standard deviation of daily price returns for the past one year.

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Performance

In the recent market scenario, funds tracking the Nifty 100 Low Volatility 30 have beaten the Nifty 50 in six-month and one-year periods. The low-volatility funds have delivered 6% returns in a six-month period, while the Nifty 50 has delivered 4% returns. The Nifty 100 Low Volatility 30 has delivered 22% returns in a one-year period, beating the Nifty 50's 19% returns.

“The low-volatility strategy tends to do well when markets are volatile or flat. However, when markets are bullish, these strategies tend to underperform significantly," said Kavitha Menon, founder of Probitus Wealth.

“Investors can use low-volatile strategies in conjunction with other strategies such as momentum," she added.

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“Momentum strategy will help investors keep in touch with that side of the market, which is outperforming, doing well, while the low-volatility basket will help the investor ensure a certain part of their portfolio remains less volatile," said Anish Teli, managing partner of QED Capital Advisors.

Know your universe

When investing in low-volatility indices, remember that the index focuses on large-caps or top 100 stocks in terms of market capitalization, and within that it is constructed on the basis of the least volatile stocks. This helps the index keep its volatility on the lower side. 

However, a momentum fund is likely to have exposure to mid-cap stocks. Its universe is going to be much wider, such as the top 250 or 200 stocks in terms of market capitalization, and within that, a basket of 30 stocks that rank high on momentum scores is created. Hence, when creating a mix of strategies, investors should understand which market segment the fund focuses on and how it affects the risk profile of the overall investment portfolio.

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