Morningstar Magazine - August/September 2017 - 25

relatively resistant to adverse trends. For example,
in 2016, low-volatility funds investing in European
equities registered modestly positive net flows of
EUR 156 million, whereas the broader Europe
equity categories saw record outflows of billions.
Even as low-volatility investing has grown, its
limitations have become apparent. Morningstar
explored this landscape in a May white paper
titled "Low Volatility: Searching for a Durable Edge:
A Tour of Low-Volatility Funds and ETFs in EMEA."
We evaluated these strategies' pitfalls-they
typically trade some market risk for other
potentially undesirable risks such as high valuation
or interest-rate exposure-and examined the
solutions active managers have devised to
tackle these issues. We also looked under the
hood, revealing biases toward smaller and higherquality companies across the equity funds
we looked at in five broad regional buckets: global,
emerging markets, U.S., Europe, and eurozone.
Low-volatility strategies are designed first and
foremost to reduce risk compared with market-capweighted indexes, and they have undeniably
delivered on that front. Our data showed that, on
average, these funds have significantly reduced
volatility when compared with their category
benchmarks and peers in the medium to long term.
The effect was less pronounced in the more
efficient U.S. equity market, however.
While these funds generally did not compete well
on total return alone, a risk-adjusted gauge such
as the Sharpe ratio is a good way to measure their
added value. Four of the five buckets outperformed
their benchmarks by that measure. Again, the
U.S. was the exception. The outperformance was
particularly significant in Europe and the eurozone.
Morningstar acknowledges the risk-reduction
benefits that low-volatility strategies can bring to
an investment portfolio over the long term.
Most of them have produced convincing results
from a risk-adjusted standpoint in recent
history. Meanwhile, actively managed low-volatility
strategies are increasingly going beyond the
traditional "minimum variance" concept by using
risk models that recognize the different sources
of risk they are exposed to. Their enhanced
models could reduce risk more effectively and

better adapt their holdings to a changing market
environment than simple low-volatility
strategies that rely on volatility and correlations.
The passive approach follows a more classical
route but retains a significant cost advantage. (The
ongoing charges of Silver-rated Europeandomiciled low-volatility ETFs range between 20
and 40 basis points.)
However, expectations that these strategies will
provide significant risk reduction without
any sacrifice of long-term return would be overly
optimistic. Given the growing popularity and
rising valuations of low-volatility stocks, future
rewards from this approach may be lower, and
investors should set their expectations accordingly.
Mathieu Caquineau is a senior manager research analyst
with Morningstar based in France.

Asian Equities as an
Income Play
ASIA

Hong Kong

Asian equity markets have traditionally been viewed
as growth vehicles, but this is changing. There
is a growing need for income-based strategies as
the baby boomer generation takes its first
steps into retirement. The global financial crisis
and subsequent zero-interest-rate policy adopted
by central banks across the globe have also
helped prompt the rise in income-based equity
strategies, which promise higher yields than
the historically low payouts on bonds, and lower
volatility than equity growth strategies.
Roughly 90% of firms within the MSCI AC Asia
Pacific ex Japan Index now pay a dividend. Two
decades ago, the figure was closer to 60%.
Payout ratios remain reasonable, leaving scope for
dividends to increase over time.

but on par with MSCI Emerging Markets and
higher than the S&P 500's yield. The region
benefits from markets such as Taiwan, Singapore,
and Australia, all with yields greater than 4%.
Government support is a key reason behind the
emergence of a dividend culture in Asia,
as governments in the region aim for more stable
global ownership of listed firms to reduce reliance
on domestic investors. Korea has levied
penalties on firms that hoard cash on their balance
sheets. Taiwan and Australia have tax policies
that encourage firms to pay dividends. In
China, the government has encouraged its
powerful state-owned enterprises to place more
emphasis on shareholder return, while some firms
listed on the growing A-shares market use
dividend policies to encourage global ownership.
One argument against income investing is that a
dividend focus would come at the expense of
growth and likely result in lower returns. However,
the MSCI AC Asia Pacific ex Japan High Dividend
Yield Index has fared considerably better than
the MSCI AC Asia Pacific ex Japan Index. Since the
former's inception at the end of 1998 through
late June, it has returned an annualized
10.9%, compared with 8.8% for the straight index.
Investors who are looking for specific strategies
that play more in the income/yield space
in Asia Pacific equities should consider First State
Asian Equity Plus or Schroder ISF Asian Equity
Yield, which are rated Gold and Silver, respectively.
The First State strategy is led by Martin Lau, who
seeks sustainable growth at attractive
valuations, aiming for a high-quality portfolio, not
merely a high-yielding one. At Schroder, lead
portfolio manager King Fuei Lee focuses on firms
with sustainable, growing dividend streams.
The introduction of a dedicated Asia Pacific exJapan equity income Morningstar Category later
in 2017 will be an important tool to help
investors choose among the increasing number
of income-orientated options in the region.
Mark Laidlaw is a senior manager research analyst with

At recent measure, MSCI AC Asia Pacific ex Japan
had a yield of 2.4%, below that of MSCI Europe,

Morningstar Asia.

global.morningstar.com/Morningstarmagazine

http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2017