Are mutual funds on the other side of the low volatility trade?
This new research helps to explain the existence of the low volatility anomaly. The paper1 examines holdings in very risky ‘lottery’ stocks of actively managed U.S. equity funds.
Funds that hold more lottery stocks are found to be smaller, younger and poor recent performers, which are characteristics typically associated with their incentives to attract capital. Funds with more retail clientele and lower managerial ownership also hold more lottery stocks. Poorly performing funds tend to increase their lottery holdings towards the end of the year.
Consistent with the existence of the low volatility anomaly, funds with higher lottery holdings are found to significantly underperform their peers, by 4.8% annually. The authors conclude that funds holding lottery stocks aim to gather assets by catering to investor preferences and engaging in risk-shifting behavior. We also like that the results help to explain why the low volatility anomaly is there in the first place, and who is on the other side of this trade.
1Agarwal, Liang & Wen, “Why Do Mutual Funds Hold Lottery Stocks”, working paper, 2018.
Our researchers publish many whitepapers based on their own empirical studies; they also follow quantitative research done by others.
