Low volatility stock investing – Does it work?

Higher
returns at lower risk?
freefincal.com/low-volatility-stock-investing/

November 6, 2018

When I start asking my audience, is it possible to get higher returns at lower risk? Many
respond that it is not possible. I enjoy the surprise on their faces when they see evidence
that low volatility stock investing works quite well and that it is possible to get higher
returns at lower risk. I had earlier presented evidence from Indian indices. In this post, let
us consider the US broad market index S &P and emerging market composite index along
with their low volatility variants.

What is low volatility stock investing?

The idea is to shortlist stocks from an index that had the lowest daily price ups and downs
over the past year or so and invest in them. If any stock turns volatile, sell them and replace
with a top low-volatile stock.

The reason why it works is, a low volatility stock portfolio protects the downside and
preserves the gains. An index created out of such low volatility stocks is called a strategic
index or a smart beta index.

freefincal and low volatility stock investing

Any regular reader would tell you that I am a fan of low risk and a reasonable return. I have
earlier published A list of stocks that have traded close to their “all-time” high and a 30 Low
Volatility Stocks from Nifty 100: Aug 2018. In addition, I am also currently conducting a lazy
investing experiment based on these low volatility stocks: Lazy Investing: Stock Test
Portfolio October 2018 (the Nov update is due)

If you watch my talk on index investing, I have established the possibility of getting higher
returns at lower risk.

List of Low volatility indices around the world

The S&P alone has a huge list of such indices ! According to the NSE, the AUM in such
index funds and ETFs is 40 billion USD (June 2017 estimate)! The indices marked in red are
studied below.

1. S&P 500 Low Volatility Index measures the performance of the 100 least volatile
stocks in the S&P 500.
2. S&P 500 Low Volatility Index (CAD Hedged) measures the performance of an
investment strategy that is long the S&P 500 Low Volatility Index hedged against the
fluctuations of the U.S. Dollar versus Canadian Dollar (CAD).
3. S&P MidCap 400 Low Volatility Index measures the performance of the 80 least
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 volatile stocks in the S&P MidCap 400.
4. S&P SmallCap 600 Low Volatility Index measures the performance of the 120 least
volatile
stocks in the S&P SmallCap 600.
5. S&P BMI Emerging Markets Low Volatility Index measures the performance of the
200 least volatile stocks in the S&P Emerging Plus LargeMidCap Index, an S&P Global
BMI sub-index.
6. S&P Emerging Markets Low Volatility Select Index measures the performance of the
50 least volatile stocks in the S&P Emerging Plus LargeMidCap, an S&P Global BMI
sub-index.
7. S&P BMI International Developed Low Volatility Index measures the performance of
the 200 least volatile stocks in the S&P Developed-Ex. US & South Korea
LargeMidCap Index, an S&P Global BMI sub-index.
8. S&P Europe 350 Low Volatility Index measures the performance of the 100 least
volatile stocks in the S&P Europe 350 Index.
9. S&P Eurozone Low Volatility Index measures the performance of the 80 least volatile
stocks in the S&P Eurozone BMI Index, an S&P Global BMI sub-index.
10. S&P Eurozone Low Volatility Index (USD Hedged) measures the performance of a
strategy
that is long the S&P Eurozone Low Volatility Index hedged against the fluctuations of
the Euro versus the U.S. Dollar (USD).
11. S&P Nordic Low Volatility Index measures the performance of the 30 least volatile
locally listed stocks in the S&P Nordic BMI.
12. S&P Southern Europe Low Volatility Index measures the performance of the 25 least
volatile
locally listed stocks in the S&P Italy BMI, S&P Portugal BMI and S&P Spain BMI.
13. S&P Developed Asia Low Volatility Index measures the performance of the 150 least
volatile
stocks in the S&P Asia Pacific LargeMidCap Index.
14. S&P Pan Asia Low Volatility Index measures the performance of the 50 least volatile
stocks in the S&P Pan Asia Ex-New Zealand LargeMidCap Index.
15. S&P Korea Low Volatility Index measures the performance of the 50 least volatile
stocks in the S&P Korea BMI.
16. S&P South Africa Low Volatility Index measures the performance of the 40 least
volatile stocks in the S&P South Africa Composite.
17. S&P EPAC Ex. Korea Low Volatility Index measures the performance of the 200 least
volatile stocks in the S&P EPAC Ex-Korea LargeMidCap Index.
18. S&P EPAC Ex. Korea Low Volatility Index (USD Hedged) measures the performance
of an
investment strategy that is long the S&P EPAC Ex. Korea Low Volatility Index hedged
against the fluctuations of the constituent currencies versus the U.S. Dollar (USD).2
S&P Japan 500 Low Volatility Index measures the performance of the 100 least
volatile stocks in the S&P Japan 500.
19. S&P Japan 500 Low Volatility Index (USD Hedged) measures the performance of an
investment strategy that is long the S&P Japan 500 Low Volatility Index hedged
against the
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 fluctuations of the Japanese Yen (JPY) versus the U.S. Dollar (USD).
20. S&P Europe 350 Carbon Efficient Select Low Volatility Index measures the
performance of
the 50 least volatile stocks in the S&P Europe 350 Carbon Efficient Select Index.
21. S&P Global Low Volatility Index measures the performance of the 300 least volatile
stocks in
the S&P Global LargeMidCap, an S&P Global BMI sub-index.
22. S&P Developed Low Volatility Index measures the performance of the 200 least
volatile stocks in the S&P Developed LargeMidCap, an S&P Global BMI sub-index.
23. S&P/ASX 200 Low Volatility Index measures the performance of the 40 least volatile
stocks in the S&P/ASX 200.
24. S&P China A-Share Low Volatility Index measures the performance of the 100 least
volatile
stocks in the combined universe of the S&P China A BMI and S&P China Venture
Enterprise
indices.

Nifty Low Volatility 50 vs Nifty 500 TRI

The low vol 50 has 50 stocks from the top 300 stocks in terms of free float market cap.
The 10-year rolling returns and rolling risk (about 1200 data points in each curve) is shown
below.

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This is proof that one can get higher returns at lower risk. If you are worried about Nifty
next 50 here, see: Are Nifty Smart Beta (strategic) Indices better than the Nifty Next 50?

S&P 500 Low Volatility Index vs S&P 500

S&P 500 Low Volatility Index measures the performance of the 100 least volatile stocks in
the S&P 500. Notice that although the performance of the low volatility index is as dramatic
as above, it is till provides S&P 500-like returns over 7 years at lower risk and this is pretty
good. It is possible that the outperformance is not as much because the US is a developed
market.

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S&P Emerging Markets Low Volatility Select Index vs S&P
Emerging Plus LargeMidCap
S&P Emerging Markets Low Volatility Select Index measures the performance of the 50
least volatile stocks in the S&P Emerging Plus LargeMidCap. There are 36 emerging
markets (page 18) including South Korean included in this index.Notice the
outperformance of the low volatility index again here.

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I should probably study more markets before concluding anything concrete, but that would
be too painful! From the results presents, once this is for sure, you get lower volatility with
a low volatility index. This seems to result in higher returns in the case of emerging markets
and commensurate return for the developed market (USA) tested. As of now, I am inclined
to believe in low volatility stock investing.

Those who are new to stock investing can consider following the method to shortlist
stocks and start using the method outlined here: How to start investing in equity?

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