Thursday, December 09, 2010

Low Volatility Investing Fun Facts

Robeco has a 'minimum volatility' portion for their webpage (see here). I'm a huge proponent, having invested this way myself. It won't make you rich, but that's why it works (ie, dominates the equity indices in return and risk). From Robeco's Pim van Vliet, here are 10 facts about Minimum Variance Portfolios, aka MVPs (edited in consideration of my web readership's busy schedule):
  1. MVPs have high exposures to low-volatility stocks and low-beta stocks.
  2. MVPs achieve risk reduction of about 33%.
  3. MVPs are a relatively new phenomenon, but the first documented alphas were found in low-beta stocks as early as the 1970s.
  4. MVPs' alpha is driven by persistent behavioral effects
    • a focus on tracking error instead of total risk. From this perspective low-risk stocks are high-risk and therefore unattractive.
    • return-seeking investors tend to prefer stocks with high risk because they are leverage constrained.
    • A large number of risk-seeking investors buy volatile stocks to get rich quickly.
    • Attention bias. Stocks of companies which are in the news have higher volatility, making them more commonly held, increasing their price and decreasing their returns.
    • The winner's curse With asymmetric information, the highest bidding buyer often pays more for a stock than its true intrinsic value.
  5. Mutual fund data suggests that the currently available low volatility products are all successful in significantly reducing downside risk, and can be done in a variety of ways.
  6. MVPs can also outperform during bull markets.
  7. MVPs generate huge tracking errors of 6-12%, but consider a stock which generates a certain 10% each year. For this stock the tracking error is equal to equity volatility of about 20%, but who would care?
  8. MVPs exhibit time-varying style exposures. MVPs had a value bias in 2006-2007, but turned to growth in 2008- 2009.
  9. MVPs tend to have somewhat higher correlation with bonds.
  10. The alpha of a MVP is very difficult to arbitrage away, in contrast to better known alphas such as valuation and momentum. To catch the alpha in the low-volatile segment of the stock market, either the market capitalization benchmark should be completely abolished and ignored, or the Strategic Asset Allocation framework should be adjusted and include a separate style allocation to MVPs


  1. Anonymous4:33 PM

    Well if you care so much about tracking error you could incorporate TE constraints into the optimization process.

  2. Anonymous6:47 AM

    TE constraints do not work if you have a beta much lower (or higher) than 1.

  3. Anonymous9:44 AM

    Yes, and when the public catches on and begins to invest this way en masse the cycles will change.

  4. Anonymous2:39 PM

    I seem to recall someone recently filed to issue minimum variance etfs, but I can't find anything now. Do you know? More generally, do you know what the options are for a retail investor?

  5. Anonymous2:31 AM

    I wonder how investing in low volatility stocks compares with a strategy of selling covered calls. My intuition is that they are similar.

    Or from the other side, compare investing in high volatility stocks with buying calls.