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Is Low-Volatility Investing Paying Off?

11 April 2013 in Trading Ideas

As one Harvard Business School professor recently put it, it’s the great anomaly in finance: the long-term outperformance of low-risk portfolios.

There’s also academic research to back it up: Harvard’s Malcolm Baker told Bloomberg that market data going back to the 1930s show that low-volatility stocks – those equities that swing the least relative to broader market moves – have delivered about the same return as broader market indexes, a phenomenon that contradicts traditional investment beliefs that higher risks lead to higher rewards.1

As Bloomberg reported, these results have also stayed true in the recent equity market, which has witnessed the strong performance of exchange-traded funds that opened since the financial crisis in order to attract investors who still seek the potential returns that equities can offer with lower price volatility.

The Low Beta motif has risen 13% in 2013, and is up 19% in the past 12 months, while the S&P 500 is up 10.2% for the year to date and 13.7% for the latest 12-month period.

What’s interesting about this outperformance (when using risk-adjusted returns), is that there isn’t a definitive reason for why it exists. According to Bloomberg, most theories revolve around the behavior of investors who become overly taken with fast-growing, glamorous companies, and then bid up the prices of those stocks to a point where future returns suffer.

But the outperformance of low-volatility stocks is neither a given nor a constant – and investors would probably be well-advised to keep in mind stretches – most of the 1990s for example, when low-volatility stocks greatly underperformed the market.

As investment strategist Joel Dickson said to Bloomberg, “As an investor you have to be willing to stomach periods when this strategy gets killed.”

That’s probably sound advice for any investing strategy you intend to follow.

1Charles Stein, “ETF Beating Market With Gains Less Price Risk: Riskless Return,” Bloomberg.com, March 19, 2013, http://www.bloomberg.com/news/2013-03-20/etf-beating-market-with-gains-less-price-swings-riskless-return.html, (accessed April 9, 2013).

Tags: low beta