What better time to launch a low-volatility equity fund than in the midst of the steepest stock selloff in years? I mean, that’s really the way to prove a low-vol concept.
Well, that’s pretty much what’s happened to a three-fund DBI (Diversification-Based Investing) suite from Legg Mason which debuted just before year’s end. DBI, according to Legg Mason’s fund runners, eschews cap-weighted exposure and instead balances portfolios according to thematic country and sector correlations. Or, more properly, discorrelation. The DBI methodology attempts to combat the concentration risk that accompanies and, it’s argued, fosters bubbles by underweighting highly correlated sector and country exposures.
Domestically, concentration risk, measured by the CBOE S&P 500 Implied Correlation Index (CBOE: KCJ), has spiked to levels not seen since last autumn’s equity swoon. A high or rising correlation index points to herding among stocks, making for bigger payoffs — short or long — on beta plays.
It’s early days still, but the Legg Mason US Diversified Core ETF (Nasdaq: UDBI) seems to be delivering the goods. In its first week, UDBI’s market price dipped 5.9 percent versus a 6.4 percent decline in the SPDR S&P 500 ETF (NYSE Arca: SPY). On an NAV basis, UDBI’s first week loss was just 5.5 percent. If volume increases, the current 19 basis point daily premium over NAV is likely to shrink.
The other DBI portfolios cover international markets – one benchmarked against the MSCI EAFE Index, the other against the MSCI Emerging Markets Index. The Legg Mason Developed ex-US Diversified Core ETF (Nasdaq: DDBI) trades at an average 44 basis point premium to NAV while the Legg Mason Emerging Markets Diversified Core ETF (Nasdaq: EDBI) premium runs at 47 basis points.
| Market Return (%) | NAV Return (%) | Market Beta | NAV Beta | |
| UDBI | -5.87 | -5.52 | .72 | .83 |
| SPY | -6.44 | -- | -- | -- |
| DDBI | -7.47 | -6.43 | .69 | .50 |
| EFA | -7.15 | -- | -- | -- |
| EDBI | -7.23 | -6.90 | .75 | 1.00 |
| EEM | -9.05 | -- | -- | -- |
Performance data: 29-Dec-15 through 7-Jan-16
So, does DBI work? So far so good, but it’ll take time and an upcycle to really see how well the strategy holds up.
Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of marketing, research and education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.
