Open up a book on Investing 101 and it will tell you that a stock's return will be directly related to its risk.
The Investing 101 book states that if you want to have high returns, you have to take on enough risk so that if you are wrong, it will end up costing you a good chunk of your portfolio. When I sit with prospective clients and I ask them about the level of risk they would be comfortable with, they inevitably say they want high returns and little risk. Most financial advisers would answer that you can't have your cake and eat it too. Either you can go for the high returns or little risk, but there is no way you can have both.
It seems that most financial advisers may be wrong, and the clients may be onto something. There was an article in Financial Analysts Journal that showed something that flew in the face of conventional financial planning: Over the 41 years ended in 2008, low-risk stocks outperformed high-risk ones. Keep in mind that if you took a few years, especially years like 2001 or 2008 when the stock market crashed, you could easily make the case that less-volatile stocks would outperform, but in good years that shouldn't happen. That's what is so surprising about the research: Over both good and bad markets, the best way to accumulate wealth over the long term was by investing in stocks with low volatility.
Slow and steady
Andrew Blackman wrote in the online edition of The Wall Street Journal: "Multiple academic studies since the 1970s have shown that low-volatility stocks outperform the highfliers over long periods, though normally one might expect higher risk to give higher returns. This surprising result has become known as the low-volatility anomaly. Researchers have traditionally explained the anomaly in behavioral terms: Investors are drawn to fast-moving stocks which have potential for spectacular gains, which then become overpriced and struggle to sustain their high valuations. The slow and steady stocks tend to be overlooked, making them bargains that are more likely to rise in value."
What's not to love?
For clients gun-shy about taking on added risk after a 14-year period that has seen two market routs, this news is a godsend. For most clients, if they can grow their portfolios over time but don't have to fret over a monthly statement that shows a huge short-term drop, then all is good.
According to Morningstar research, low-volatility investing has become popular. For investors considering the strategy, there were recently 37 low-volatility mutual funds and 14 ETFs. These products have combined assets of more than $16 billion. That suggest strong inflows into these products in a very short period of time.
Not all roses
There are many market pundits out there who say this strategy has become so popular that the low-volatility stocks themselves have become quite expensive. While they can't argue with the long-term success of the strategy, they caution investors to wait for a pullback before buying into these funds.
As I have written numerous times, whatever strategy you choose to invest in, stick to it. Investors who jump from strategy to strategy, or try and cherry-pick certain stocks from one strategy and stocks from another, tend to end up losing money, even in bull markets.
Blackman quotes Andrew Schlossberg, head of U.S. retail distribution and global ETFs at Invesco Ltd., as an answer to the pundits:
"The important thing on low-volatility investing is to look at it over a full market cycle. The research has shown that low-volatility investing can reduce risk in your portfolio and allow you to get adequate return, which is what everyone is trying to do."
Investors should speak with their financial professional to see whether low-volatility investments have a place in their portfolio.