# Is the low-beta trade going sour? ZLB



## james4beach (Nov 15, 2012)

Many of us around here (including myself) have been intrigued by ZLB, the BMO ETF that follows a low-beta / low-volatility approach. It has shown amazing outperformance since inception five years ago and accumulated $1.3 billion in assets, which is spectacular for a new Canadian ETF.

Is it possible this strategy is now going sour? Since September, ZLB has declined worse than the TSX (4% peak-to-trough decline in ZLB versus 2% decline for XIU). Here are its top 10 holdings; about 1/2 of the top holdings are showing high volatility right now!

FFH - stunning selloff even while the financial sector is generally strong
DOL - fine
WCN - fine
IFC - fine
REF.U - significant selloff
BCE - fine
CSU - fine (up strongly)
EMP.A - doing badly for quite a while
EMA - significant selloff
REI.UN - significant selloff

Compare that to some top holdings in TSX 60, and here I'm showing the top per sector to mirror ZLB's sector diversification. Otherwise it will just be a list of mostly the same sectors which won't give a representative snapshot.

RY - fine
SU - fine (up strongly)
CNR - fine
BCE - fine
ABX - fine
ATD.B - fine
MG - fine
FTS - fine
GIB.A - fine
VRX - crazy high vol

That's interesting to me. It makes me wonder if ZLB's fundamental trade has blown up (reversed) on them, with about 50% of ZLB's top holdings showing high volatility recently while only 10% of XIU's top holdings per sector are showing it.


----------



## doctrine (Sep 30, 2011)

I never liked ZLB because the top holdings tended to be high valuation stocks. And while some were higher growth stocks, it was rarely GARP - growth at a reasonable price. It was usually very high value, medium or slower growth companies. A P/E of 30 for 10% growth is very overpriced, in my opinion.

That being said, it actually looks like the cheaper holdings of ZLB are the ones that are selling off. CSU, WCN and DOL continue to trade at nosebleed levels.


----------



## Argonaut (Dec 7, 2010)

REITs have been on the pain train for the last couple of months. Partially to do with some of the talk of a housing bubble, I wager. These have low betas not necessarily because they are low volatility, but because they have less correlation with the market.

That brings up the point that I don't know whether an index of low beta stocks can accurately be called low volatility, though it does appear to be that way a lot of the time. It just has lower correlation to the market. Maybe they also screen for stocks with a low standard deviation of returns as well. I think that is a better measure of volatility than beta. I mean, Goldcorp has a beta of -0.30. Is that considered low beta?


----------



## james4beach (Nov 15, 2012)

I assumed ZLB was intended to be low volatility as that's what they call it in the name. This paper describes ZLB portfolio construction strategy
http://thehub.bmosalessupport.com/s...t_-_etf_-_eng_0.pdf/?file=1&type=node&id=8952

Beta is the primary screening criteria. There is no mention of standard deviation or other volatility measures. BMO seems to be saying that low beta stocks are low volatility stocks.


----------



## Argonaut (Dec 7, 2010)

Looking at the ZLB holdings, you can see that a basic eye-test reveals that they are probably the low-volatility names people think of. But I don't think that a screen on a stock's beta is going to match their holdings, like it says in their fund description. Alimentation Couche Tard (in ZLB) for instance has a similar beta to Goldcorp (not in ZLB). But one is obviously more volatile than the other. Valeant is probably the most volatile stock on the TSX, yet its beta is -0.59. BMO must use either standard deviation or some common sense in addition to beta to screen their selections.


----------



## Mike-RetireEarly (Feb 28, 2016)

There is some decline in ZLB due to a move away from the low volatility trade, but I think sector weightings is more to blame for the under performance. ZLB will at times will underperform the TSX because of it different sector/stock weightings. 

ZLB is underperforming this year due to the low weighting in Materials and Energy stocks (2.69% and 3.3%) vs XIU (11.27% and 20.88%). See the following chart: http://stockcharts.com/freecharts/p...TEN,$SPTCD,$SPTFS,$SPTCS,$SPTUT,$SPTRE,XIU.TO

The low weighting in Materials and Energy stocks is also why ZLB performed better in 2015 vs XIU.

It'll be interesting to compare the two when there is a full market cycle of history, say about 10 years of history.


----------



## CPA Candidate (Dec 15, 2013)

The interest rate sensitive names are selling off. The sell on interest rate expectations "trade" is coming back to life, which has been a buying opportunity each time. Economic growth and inflation remain weak, interest rates are not making any meaningful move up. Don't get caught up in market noise.

The Canadian 10 year bond on Nov 3, 2011 was 2.09%. 5 years to the day, 1.18%. How many times have interest rate sensitive names sold off because of rate expectations? Too many to recall.


----------



## james4beach (Nov 15, 2012)

Mike-RetireEarly said:


> The low weighting in Materials and Energy stocks is also why ZLB performed better in 2015 vs XIU.
> 
> It'll be interesting to compare the two when there is a full market cycle of history, say about 10 years of history.


I agree that this sector composition is a big factor. It's something I'm hesitant about with ZLB. Sure, this strategy will work well as long as commodities are out of favour (we've been in a commodity bear market). But let's see what happens when commodities are the driver of the TSX.

I'd like to see a longer history on ZLB. As you say, let's see 10 years of history and how it handles full cycles including commodity booms.


----------



## My Own Advisor (Sep 24, 2012)

I wouldn't own ZLB myself. I would definitely put my money into XIU, and I do. These are the biggest companies in Canada. Yes, you have some volatility with XIU, as with XIC, but my thesis is if the 60 biggest companies in Canada aren't making money then nobody is. 

We are an economy of oligopolies outside of a few peak performing stocks that rise and then fall over time.

There is no way Argo or others would ever put a penny into ZLB but I could be wrong.


----------



## Argonaut (Dec 7, 2010)

ZLB is very overweight Consumer Staples, and I think this is a big reason for its great performance in the last 5 years. This has probably been the very best sector in Canada during that time period. I could see Consumer Staples underperforming in the future.. probably overvalued now. I'm not interested in this sector for my 6-pack.. margins are too low and the dividends are in the 1% range.. too many competitors in the industry.


----------



## james4beach (Nov 15, 2012)

Great observations, all. I'm not anywhere close to investing in ZLB or recommending it to family, but it's still on my radar to watch.


----------



## latebuyer (Nov 15, 2015)

I hold some zlb and xic because i think no one knows what will happen with oil. Sure returns for xic are great now but that may change. When zlb has different sector weightings you can expect different returns. I think that is the whole point that when xic tanks, zlb will hold up but you can also expect vice versa.


----------



## james4beach (Nov 15, 2012)

ZLB continues to underperform... it's been a very bad period for it, vs the regular TSX 60 or TSX Composite.

This is interesting; this is the scenario where you wonder, do I have faith in ZLB's methodology enough to think that it will continue to perform well, and therefore I will keep pumping money into it? Or is it that whatever market conditions that made ZLB perform so well, have finally ended (reversion to the mean) and it's pointless going forward?


----------



## wraphter (Sep 21, 2016)

Rob Carrick explains why ZLB has underperformed lately.




> Low-volatility exchange-traded funds had a great run of doing exactly this. The BMO Low Volatility Canadian Equity ETF (ZLB) had a cumulative return of 85.5 per cent for the five years to Nov. 24, while the BMO S&P/TSX Capped Composite Index ETF (ZCN) made 32.3 per cent. But lately, the low volatility strategy has lagged. ZLB was up 5.5 per cent for the past 12 months, while ZCN was up 12.3 per cent.
> 
> .......
> 
> ...


----------



## james4beach (Nov 15, 2012)

Interesting, thanks. I also wonder how much of it has to do with plain old sector exposure.

XIU is 40% financials, 22% energy, 10% materials.
ZLB is 24% financials, 15% consumer staples ... practically nil energy & materials.

Here is YTD sector performance based on iShares sector ETFs
materials +44% beating average
energy +38% beating average
financials +21% average
consumer staples +8% well below average

When you look at sector exposures, XIU has benefited enormously from its energy and materials exposure. ZLB totally misses out by having no commodity exposure. Even worse, one of their dominant sectors (consumer staples) has done much worse than average.

If we continue to have a strong commodities rally, XIU and XIC are going to leave ZLB in the dust. I doubt anyone can predict which way this is going to go.


----------



## james4beach (Nov 15, 2012)

Interestingly, Mawer Canadian Equity (another historic out-performer) has been doing badly YTD vs XIU. It's up 13.6% vs 20.6% for XIU

This is another fund that underweights materials & energy. So perhaps we shouldn't be hard on ZLB for under-performing... it's a common theme to these funds that under-weight commodities, including Mawer Canadian Equity


----------



## Argonaut (Dec 7, 2010)

Couple points. I don't think lack of commodities is necessarily the issue. The 5-Pack Portfolio is outperforming XIU this year, and it has no commodities (sort of). And remember that the commodity outperformance YTD is just phantom outperformance, all these stocks are doing is clawing their way back a little ways out of a big hole. I think avoiding commodity stocks is still a good play long-term.

As I said upthread, I think the underperformance of ZLB is more to do with its overweight of Consumer Staples, which has been a bad place to be lately. The 5-Pack doesn't have Consumer Staples so I haven't experienced this. So the dividend stock trade is still alive and well. Bank/Railroad/Telecom/Pipeline/REIT has a good mix of defensive and cyclical-ish without being as volatile as the broad market.


----------



## james4beach (Nov 15, 2012)

I see what you mean. My own XIU unbundling also doesn't have any consumer stocks and has similarly been keeping up with XIU. I plan to add to my unbundled XIU at year end.


----------



## My Own Advisor (Sep 24, 2012)

"Interesting, thanks. I also wonder how much of it has to do with plain old sector exposure.

XIU is 40% financials, 22% energy, 10% materials.
ZLB is 24% financials, 15% consumer staples ... practically nil energy & materials."

When I see the results of ZLB, I'm very happy to stick with my unbundled, 20-30, selected assortment of XIU stocks directly.

I have always owned the banks/telcos/pipelines/REITs for my stock portfolio and it has served me well since 2009.


----------



## latebuyer (Nov 15, 2015)

Thats fine to use stocks in an rrsp but what do you do in a tfsa? I am only contributing 3000 per year to my tfsa to invest. Would something like investing in 1 bank stock work? Keep in mind the tsx was down for something like 2 years so i'm not keen to invest in it. While i do see my tfsa for retirement, i think i would use it over my rrsp if i was in dire financial straights. Interesting to see if you averaged zlb and xic over time which would come out ahead since that is whats important. I have a balanced portfolio so only 1000 would go towards my canadian allocation.


----------



## andrewf (Mar 1, 2010)

wraphter said:


> Rob Carrick explains why ZLB has underperformed lately.


I think a better explanation is that low vol became expensive/overpriced.

Research Affiliates had a great bit of research looking at the performance of different strategies (such as low vol) depending on their relative price to the market.

https://www.researchaffiliates.com/...ith_smart_beta_ask_if_the_price_is_right.html


----------



## james4beach (Nov 15, 2012)

I think 2016 is the first year the ZLB did worse than the broad market. XIU/XIC was up 21% for the year, and ZLB was up 13% -- significantly under performing. (Although +13% is hardly disappointing).

To give more context though, if you look at 2015 & 2016 together, the combined total performance for the two years is XIC +10% and ZLB +16% which still makes ZLB the winner.

Do you think ZLB remains a good investment? It's hard to ignore a well diversified ETF like this with a 5 year average return of 15% per year, beating the TSX by quite a bit.

http://quote.morningstar.ca/QuickTakes/ETF/etf_performance.aspx?t=ZLB&region=CAN&culture=en-CA


----------



## My Own Advisor (Sep 24, 2012)

I think 13% is poor given the returns of XIU/XIC/ZCN/VCN. No?


----------



## mordko (Jan 23, 2016)

Not a fan of the low vol. factor. You are basically picking industries. Clearly there will be a span of time when these industries will outperform and a span of time when they will underperform. That exposes people to behavioural problems. Industries have ups and downs, sometimes due to a single scare or a major accident. That's ok if you really know the business; otherwise you are just increasing the risk by reducing diversification.


----------



## james4beach (Nov 15, 2012)

I'd agree 13% is bad when the broad TSX Composite did so much better. For the one year, anyway.

mordko - but ZLB has good sector balance, it's not too concentrated in specific industries. 23% financials, 14% consumer staples, 13% utilities, 12% real estate, 10% consumer discretionary, 8% telecom, 6% tech, 5% industrials, 4% metals, 3% energy.

It's the TSX index that's concentrated in specific industries. It benefited from tremendous bank performance, and when financials slow down, it will suffer due to that.


----------



## doctrine (Sep 30, 2011)

ZLB did incredibly well for years. Now it lags the TSX index for the last 12-18 months. Does that make it a poor index, or does it mean it is now cheaper than the index and future returns in ZLB may exceed XIU? Hard to say of course, but it would be worth considering hindsight bias before dumping the merits of the strategy. I don't necessarily like ZLB, but it is very interesting that strategies that outperform will almost always underperform, sometimes by large amounts for long periods of time.


----------



## hboy54 (Sep 16, 2016)

Hi:

ZLB in a sense exists to eject the volatility of materials that is present in a broader index. It hardly seems fair to shoot it when it in fact does this: it successfully avoided materials volatility, it just happens that it was upward volatility.

Hboy54


----------



## Spudd (Oct 11, 2011)

hboy54 said:


> ZLB in a sense exists to eject the volatility of materials that is present in a broader index. It hardly seems fair to shoot it when it in fact does this: it successfully avoided materials volatility, it just happens that it was upward volatility.


+1


----------



## james4beach (Nov 15, 2012)

I also don't knock ZLB ... we know it avoids commodities in general. Can't blame it for that. I'm also not giving up on it, continue to be quite interested in this one. (I don't hold it)


----------



## My Own Advisor (Sep 24, 2012)

I have no problem with ZLB as a product, I think it's good, my point is - if you owned it just for the last year compared to the broad market you might be very disappointed.

Low vol. ETFs make sense. So does holding many of the top-10 stocks and paying no fees as well.


----------



## james4beach (Nov 15, 2012)

The ZLB "magic" seems to be back on. The year-to-date performance of ZLB has been great.

1 year returns to April 17:
ZLB +12.76%
XIU +18.80%

I still think that good sector balance is a key reason ZLB does so well. This is a common trait with CDZ, another consistent outperformer.


----------



## latebuyer (Nov 15, 2015)

According to morningstar zlb has a 5.83% allocation to us equity which i found odd. It may have helped boost returns.


----------



## james4beach (Nov 15, 2012)

That's interesting. The list of holdings shows all Canadian securities but I wonder if they consider US exposure within some, such as ONEX (private equity) that has considerable US exposure.

I'm still interested in ZLB, more for its sector diversification and good looking holdings. It will be interesting to see how it handles a market downturn.


----------

