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Decline

Anomaly

This is a phenomenon that cannot be explained by standard theories. In the case of investing, these are often divergences from the CAPM*, which assumes that investors are rational and that there is a linear correlation between risk and return.

The theory of 'behavioral finance' has since questioned the hypothesis of investor rationality. One well-known anomaly is the low-volatility (low-vol) anomaly. Based on the CAPM*-based theory, low-volatility equities can be expected to realize lower returns than high-volatility equities, since rational investors will only want to run more risk if they are rewarded for this in the form of extra returns. In practice, however, it can be seen that risk and return are less strongly correlated than is often thought.

Figure 1. Historical performance characteristics of US equity portfolio, July 1963 - December 2010
Source: Blitz (2012), Strategic Allocation to Premiums in the Equity Market, Journal of Index Investing

The value of your investment may fluctuate. Results obtained in the past are no guarantee for the future.

* CAPM = Capital Asset Pricing Model