Low-volatility stocks are known to lag in rising markets and lose less in falling markets. On average this is true, but is it always the case? Examining the historical evidence we find that unlikely scenarios – both positive and negative - do occur once in a while. Low-volatility investors should therefore not only focus on averages, but consider a broader range of possible outcomes.
It is well-known from behavioral economics that people tend to be overconfident. One of the manifestations of overconfidence is that people overestimate their ability to predict a certain number. For example, when asked to set a range within which a number will fall with a 90% certainty, most people set the range too narrow, capturing only 40% of the correct answers.
Such overconfidence raises the concern that investors may also underestimate the range of possible outcomes from a low-volatility investment strategy. Although we do not challenge base case expectations, we want to make investors aware of the uncertainty around the average, most likely scenario. The range and likelihood of possible scenarios are typically underestimated and investors should increase the volatility around their expectations. For example, the probability that low volatility outperforms during a down market is not 100% or 99% as often implicitly assumed, but closer to 90%. Low-volatility investors tend to profit from the overconfidence of other investors, but should be careful not to fall victim to the same bias themselves.
Having examined the historical data, we find that low-volatility stocks do not always behave according to general expectations. Investors should therefore be prepared for the unexpected. All kinds of unlikely scenarios for low-volatility, which would probably shock many investors if they were to occur today, actually turn out to have happened already at some point in the past – and often more than once as well. In the short run such unusual behavior should not be an immediate cause for concern, because it does not change the highly appealing long-run performance characteristics of low-volatility strategies: equity-like (or even better) average returns, with less volatility and downside risk. Patience and persistence are needed in order to successfully harvest the low-volatility premium, and investors should not change course if ideal outcomes do not materialize at some particular point in time.
Our research shows that low-volatility stocks can underperform in falling markets, and also the realized volatility of low-volatility strategies sometimes exceeds that of the market. Currency effects can also lead to distortions, although a currency hedge might mitigate this problem. On the other hand, we have also observed that outperformance of low-volatility stocks in strongly rising markets is not as unlikely as one might think, but actually a quite frequently occurring event.
Robeco Conservative Equities is our enhanced low-volatility approach. The real-life results since 2006 show that the likelihood of underperformance in down markets is about 10%. This is in line with long-term results and also with the MSCI Minimum Volatility index over this period. Again in line with the long-term analysis, 1-year volatility was reduced roughly 80% of the time, and the 20% of cases with higher ex post volatility all occurred during up markets. For EUR investors the currency hedged version of the Conservative Equity strategy had a higher frequency of volatility reduction. Finally, the probability of outperforming in a rising market over a one-year period was over 50%, leading to improved up-capture. This is also in line with long-term results and a positive result for our clients.
In short, our research shows that low-volatility investors should not only focus on averages, but consider a broad range of possible outcomes and prepare for the unexpected. Low-volatility investors tend to profit from the overconfidence of other investors, but should not fall victim to the same bias themselves. A broad view will help to strengthen the long-term commitment needed to successfully profit from the low-volatility anomaly.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.