Low Vol - High Vol - Big Vol

by: Douglas Tengdin, CFA

Well that was fast.

Performance of Low Vol/High Dividend Strategy vs. S&P 500. Source: Bloomberg

For the past year, the investment world has been buzzing about the success of "low volatility" strategies. The idea is that less-volatile stocks can give you just as much performance as highly-volatile stocks, without all the heartache. In other words, in the great risk-return tradeoff, there may be something like a free lunch - more return with less risk. Like the old Bud Lite commercial: great taste and less filling.

But it doesn't usually work out that way. As the chart above shows, low-vol strategies have languished since July. That's because the stocks that comprise that portion of the index have been in the doghouse: healthcare firms have been beaten up over worries about health care legislation, and a lot of consumer products firms - which are big exporters - have been roiled by a stronger dollar. A strong dollar makes overseas sales less valuable to US dollar-based investors.

But is this just a seasonal turn? Let's look at the underlying premise. Do low-volatility stocks perform just as well as the overall market over the long run?

Source: Bloomberg

The short answer would seem to be no. Since 1994, the broad market has grown 9.5% per year, while low-vol stocks have returned about 1.2% less than that. It's possible that you could lever the returns of low-vol stocks to get them higher, but then the leverage would add volatility and you'd be right back where you started.

There is no secret sauce to the stock market to create higher returns with lower risk. It may seem that such an approach is working, but often that's a statistical quirk - something that asserts itself over a short period of time, to be disproven as later periods favor new factors.

Source: ETF Trends

The market is always shifting. As soon as you think you've figured out the key, it changes the locks.

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