Since their launch in mid-2011, low volatility and minimum volatility indices have been written about extensively in financial literature, and their index-linked investment vehicles have grown to track a significant amount of assets. The widespread adoption of the strategies by retail and institutional market participants to gain exposure to the low volatility factor indicates that low-risk investing is here to stay. Against that backdrop, it is important that market participants understand the fundamental differences between the two established forms of low-risk index construction: rankings based versus optimization based.
As a leading provider of factor indices, S&P Dow Jones Indices (S&P DJI) publishes both forms of low volatility indices for the domestic large-cap universe, as represented by the S&P 500. While both indices have historically outperformed the underlying S&P 500 universe with lower realized volatility over a long-term investment horizon, the two have little else in common. We note that there are meaningful differences regarding their risk/return profiles, sector composition, and factor exposures, and we highlight these differences using the S&P 500 Low Volatility Index and the S&P 500 Minimum Volatility Index to represent the two types of low volatility strategies. As such, this paper is meant to serve as a practical guide for market participants who are looking to understand the impact of index construction differences.