Many academic studies have shown that low-volatility stocks can outperform high-risk stocks or even general stock market indices. For example, Geoff Considine pointed out:
If we sort using beta, (a standard proxy for risk) rather than volatility, the low-beta stocks have historically generated substantially higher returns than their high-beta counterparts. The outperformance provided by selectively building a portfolio out of low-beta/low-volatility stocks is on the order of 2.0% per year, as compared to buying a portfolio in a market-cap weighted index such as the S&P 500 Index.
This article takes one step further: identify high momentum stocks from the list of low-volatility stocks. The low-volatility stocks are from the 100 stocks held currently by S&P Low Volatility Stock ETF (NYSEARCA:SPLV). A portfolio is constructed as follows:
- Rank stocks from the 100 low volatility stocks based on their momentum scores. The momentum scores are derived using the average of 1,3,6 and 12 month total returns.
- Choose 10 stocks that have the highest momentum scores. If any one of these 10 stocks has momentum score lower than cash, cash is used instead. Invest equally in these 10 stocks for one month.
- Repeat the above in the next month.
The portfolio P SPLV S and P Low Volatility Stocks With Momentum has the following back test result:
Annualized Return (up to 5/4/2012)
|P SPLV S and P Low Volatility Stocks With Momentum||12%||16%||19%||4%|
|VFINX (Vanguard (S&P 500) Index)||10%||4%||17%||0%|
|VBINX (Vanguard Balance (60% stocks/40% bonds)||6%||5%||14%||3%|
* AR: Annualized Return
** YTD: Year to Date (not annuallized)
More detailed performance
The portfolio has out performed VFINX (NYSEARCA:SPY) by a big margin. This further validates the low volatility stock theory.
Currently, this portfolio holds the following 10 stocks:
|Asset||Fund in this portfolio||Percentage|
|Asset0||(NASDAQ:ORLY)(O'Reilly Automotive Inc)||9.91%|
|Asset1||(NYSE:SHW) (Sherwin-Williams Company)||10.09%|
|Asset2||(NASDAQ:ROST)(Ross Stores, Inc.)||10.17%|
|Asset4||(NASDAQ:DLTR)(Dollar Tree Stores, Inc.)||10.04%|
|Asset5||(NYSE:PM)(Philip Morris International, Inc.)||9.98%|
|Asset9||(SLE)(Sara Lee Corporation)||9.98%|
O'Reilly Automotive (ORLY), TJX (TJX), Philip Morris International (PM), AutoZone (AZO), Dollar Tree (DLTR) and Sara Lee (SLE) are all the author's favorite stocks, as they all have solid business models and necessary brand names. Furthermore, they have exhibited both earnings growth and price appreciation.
In the current volatile environment, these stocks can provide good anchor to stabilize a portfolio.