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From these two exhibits, we find that in both periods, the Sharpe ratio of the least volatile stocks in a given sector was higher than the ratio of their most volatile peers almost everywhere. It is reassuring to see the foundations of our low volatility investment philosophy confirmed in the out-of-sample data.
Our results show how important it is for low volatility strategies to be diversified and to be invested in the least volatile stocks of all sectors. Blindly minimising volatility, creating strong biases towards a small number of least volatile sectors, should not be the goal of low volatility investing.
Because of the defensive beta, we can say that low volatility stock portfolios are likely to outperform the market capitalisation index when market returns are negative, but it is not certain that they will. Even if the alpha of low volatility stocks is positive on average over the medium and long-term, which explains their higher Sharpe ratios, since by definition the alpha is fully uncorrelated with market returns, the occasional negative short-term alpha during a market fall that may lead to underperformance is almost inevitable.
Similarly, episodes of outperformance of low volatility stock portfolios even when the market rises , explained by the positive alpha of low volatility stocks, should not surprise. Source: What returns can be expected from investing in low volatility equities. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice.
Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions social, political and economic conditions.
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
A round-up of this week's key economic and market trends, and insights on what to expect going forward. The low volatility anomaly in sectors Ten years ago, we launched our equity low volatility strategy, which was based on proprietary research on low-risk stocks. Takeaways It is reassuring to see the foundations of our low volatility investment philosophy confirmed in the out-of-sample data.
LinkedIn Twitter Facebook Email. Related articles MIN. Agne Rackauskaite. Daniel Morris. Talking heads — Solutions to improve food security. Asset allocation update — A deeper short in European equities. Disruptive technology — Maintaining course in volatile markets. So, falling interest rates provide some tailwinds, while rising rates tend to be a headwind. But now that they have reached zero, or even negative levels in numerous developed markets, can they still deliver in a world with structurally low rates, or if rates were to start rising again?
To assess the potential adverse impact of increasing rates, we take into account a like scenario. In our research, we estimated that low volatility stocks have a beta relative to bonds of about 0. Taken at face value, this is quite a sizable blow. In other words, the impact of rate changes is essentially a second-order effect, that is typically overwhelmed by the influence of other factors — i.
There is also the alternate, and arguably more likely, scenario that interest rates will remain low for many years. History suggests that low interest rates are not necessarily problematic for low volatility stocks. In one of our studies, we found that the volatility factor was able to deliver solid returns in the US during the s and s, when interest rates were structurally low. In this paper, we showed that low volatility investors should be prepared for this kind of unexpected outcomes using 85 years of historical data.
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Stay informed on Quant investing with monthly mail updates. Low Volatility is short exuberance and junk Low volatility stocks tend to be mature firms with stable earnings and high dividends, which relates to the academic investment, profitability and value factors.
In addition to being short exuberance, low volatility strategies are also short junk Therefore, in addition to being short exuberance, low volatility strategies are also short junk. Alpha volatility can momentarily cause aberrations Many investors count on low volatility strategies to provide them with capital preservation during severe market downturns.
Individual investor behavioral biases could strengthen Low Volatility anomaly Investors tend to overpay for riskier stocks and underpay for safer ones. Low Volatility strategies can still deliver in prevalent interest rate environment Numerous studies have established that low volatility stocks exhibit bond-like properties. Read the full article. Subjects related to this article are: Conservative equities Quant investing Low volatility Factor investing David Blitz.
Forecasting stock crash risk with machine learning. Related articles See all Forecasting stock crash risk with machine learning. Guide to sustainable quant equities investing. Quality: the underappreciation of well-managed businesses. Beyond Fama-French: alpha from short-term signals. Related strategies Conservative Equity. Disclaimer The information contained in the website is solely intended for professional investors.
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