Low Volatility investing: now more than ever

Low Volatility investing: now more than ever

01-06-2021 | Insight

Low Volatility strategies can handle changes in the investment landscape. This includes the rise of the retail investor, and low or increasing interest rates. Despite the recent performance challenges, we also believe the case for Low Volatility investing has actually  strengthened.

  • David Blitz
    Chief Researcher

Speed read

  • Short exuberance and junk positioning helps explain underperformance 
  • Recent rise of retail investor could support Low Volatility anomaly  
  • Low Volatility stocks can potentially deliver in current interest rate context 

Popular low volatility indices have significantly lagged their parent indices since the autumn of 2019. The recent woes for the factor can be explained by the fact that the market has been in ‘risk-on’ mode, i.e. riskier assets have fared better than safer ones.

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates

Low Volatility is short exuberance and junk

Low volatility stocks tend to be mature firms with stable earnings and high dividends, which relates to the academic investment, profitability and value factors. Given these style characteristics, low volatility strategies generally tend to struggle during rallies of expensive risky stocks, with rapidly growing balance sheets and weak profitability. 

While it is important for investors to be cognizant of this vulnerability of low volatility strategies, they should not interpret it as a fatal flaw, because the growth rallies in question are not supported by improving firm fundamentals. Instead, they are fueled by massive multiple expansion, which eventually tends to mean revert. Thus, low volatility strategies are short exuberance, and although this can cause significant underperformance in the short run, this positioning ultimately pays off in our view.

Low volatility strategies also tend to suffer when distressed stocks rebound. These so-called ‘junk rallies’ tend to be shorter-lived phenomena than the growth rallies discussed above, but share many similarities from a factor perspective. The stocks in question tend to involve high uncertainty, low dividends, a need for fresh capital and low profitability. 

In addition to being short exuberance, low volatility strategies are also short junk

Therefore, in addition to being short exuberance, low volatility strategies are also short junk. These features help explain the major drawdowns of low volatility strategies, but also highlight the main risk that investors need to accept in order to harvest the low volatility premium in the long run.

Alpha volatility can momentarily cause aberrations

Many investors count on low volatility strategies to provide them with capital preservation during severe market downturns. But during the Covid-19-induced market crash in the first quarter of 2020, the downside protection they offered mostly fell short of expectations.1  

Low volatility portfolios are characterized by a beta well below 1 and a positive expected alpha which reflects their long-term added value. However, the alpha does not come in a smooth, steady return stream, but involves a considerable amount of uncertainty. Using data from real-life low volatility strategies, we can estimate that the alpha is associated with a volatility of about 6% on an annualized basis.2 

The effects of alpha volatility are illustrated in Figure 1 using a Monte Carlo simulation. The black diagonal line reflects the benchmark return and the grey line represents the expected return of a portfolio with a beta of 0.7 and no alpha. The dots depict 2,500 simulated portfolio returns assuming an expected alpha of 2% and taking into account the effects of 6% alpha volatility. The blue dots denote positive alphas, the orange dots negative alphas but with some downside protection, and the purple dots negative alphas with no downside protection. 

Figure 1 | Simulated illustration of the impact of alpha volatility on Low Volatility performance

Source: Robeco Quantitative Research

Although low volatility strategies typically provide the expected protection during market downturns, there is always a non-negligible probability that they do not. The important thing, however, is that this does not invalidate low volatility investing, especially over the long run. This tail risk is inherently present in low volatility strategies. Without alpha volatility, low volatility investing would just be too good to be true, with a 100% downside protection rate accompanied by a positive alpha.

Figure 1 also helps to explain another counterintuitive result, specifically that low volatility strategies can outperform when the market delivers double-digit positive returns. Therefore, low volatility strategies cannot only surprise negatively, by underperforming in a down market, they can also surprise positively, by outperforming in an up market.3 

Individual investor behavioral biases could strengthen Low Volatility anomaly

Investors tend to overpay for riskier stocks and underpay for safer ones.For professional investors, the key issue is that they are lured away from safer stocks towards riskier ones due to the pressure to beat benchmarks and peers. Individual investors appear to be attracted to risky stocks for different reasons, most notably their resemblance to lottery tickets. 

For example, recent research examines the performance and trading behavior of investors using the commission-free Robinhood trading app.5  This study finds that these investors exhibit strong herding behavior, with a preference for buying risky, attention-grabbing stocks. This is clearly the kind of individual investor behavior that is related to the low volatility anomaly

Exchange-traded funds (ETFs) is another innovation that has been massively embraced by individual investors. One study examines specialized ETFs that track niche portfolios and charge high fees. The researchers find that these products hold stocks with characteristics that are appealing to retail and sentiment-driven investors, such as high recent performance, media exposure and sentiment.6  This is again typical of the kind of behavior that supports the low volatility anomaly.

At Robeco, we recently examined the low volatility effect in the local Chinese stock market, which offers a rare opportunity for what we believe to be a true independent out-of-sample test. Moreover, it is a market that is heavily dominated by individual investors. In our research, we uncover the presence of a strong low volatility effect in the Chinese A-share market.7   

The recent rise of the retail investor is more likely to strengthen than to weaken the low volatility anomaly 

Thus, we believe the recent rise of the retail investor is more likely to strengthen than to weaken the low volatility anomaly, as these investors are particularly prone to the kind of behavioral biases which cause risky assets to become overpriced. 

Low Volatility strategies can still deliver in prevalent interest rate environment

Numerous studies have established that low volatility stocks exhibit bond-like properties. So, falling interest rates provide some tailwinds, while rising rates tend to be a headwind.8  For 40 years, low volatility strategies were able to benefit from steadily decreasing rates. But now that they have reached zero, or even negative levels in numerous developed markets, can they still deliver in a world with structurally low rates, or if rates were to start rising again? 

To assess the potential adverse impact of increasing rates, we take into account a 1994-like scenario. During this ‘annus horribilis’, 10-year Treasury yields rose by 200 basis points and average bond returns were about -10%. In our research, we estimated that low volatility stocks have a beta relative to bonds of about 0.3.9  In such a scenario, low volatility strategies would, therefore, take an expected hit of -3% (= -10% x 0.3). 

Taken at face value, this is quite a sizable blow. However, compared to the regular alpha volatility of about 6% per annum, it is not particularly extreme. In other words, the impact of rate changes is essentially a second-order effect, that is typically overwhelmed by the influence of other factors – i.e. alpha volatility – on the performance of low volatility strategies at all times.

There is also the alternate, and arguably more likely, scenario that interest rates will remain low for many years. History suggests that low interest rates are not necessarily problematic for low volatility stocks. In one of our studies, we found that the volatility factor was able to deliver solid returns in the US during the 1940s and 1950s, when interest rates were structurally low.10 

Altogether, we believe the case for low volatility has not weakened, but in fact strengthened.

1See: Mosselaar, J.S., 2021. “Dissecting the 2020 performance of low volatility indices.” Robeco article.
2This estimate is based on long-term data for the Robeco Global Conservative Equities strategy and the MSCI World Minimum Volatility index, both in EUR.
3See: Blitz, D., and van Vliet, P., 2014. “Low volatility investing: Expect the unexpected”, Robeco white paper. In this paper, we showed that low volatility investors should be prepared for this kind of unexpected outcomes using 85 years of historical data.
4Blitz, D., Falkenstein, E., and van Vliet, P., 2014. “Explanations for the volatility effect: An overview based on the CAPM assumptions.” Journal of Portfolio Management 40(3), 61-76.
5See: Barber, B., Huang, X., Odean, T., and Schwarz, C., 2020. “Attention induced trading and returns: Evidence from Robinhood users.” SSRN working paper, no. 3715077.
6See: Ben-David, I., Franzoni, F., Kim, B., and Moussawi, R., 2021. “Competition for attention in the ETF space.” SSRN working paper, no. 3765063.
7See: Blitz, D., Hanauer, M., and van Vliet, P., 2021. “The volatility effect in China” Journal of Asset Management, forthcoming.
8See: Baker, M., and Wurgler, J., 2012. “Comovement and predictability relationships between bonds and the cross-section of stocks.” Review of Asset Pricing Studies 2(1), 57-87; De Franco, C., Monnier, B. and Rulik, K., 2017. “Interest rate exposure of volatility portfolios.” Journal of Index Investing 8(2), 53-67; and Blitz, D., 2020. “The risk-free asset implied by the market: Medium-term bonds instead of short-term bills.” Journal of Portfolio Management 46(8), 120-132.
9Blitz, D., van der Grient, G., and van Vliet, P., 2014. “Interest rate risk in low volatility strategies”, Robeco white paper.
10See: Blitz, D., van Vliet, P., and Baltussen, G., 2020. “The volatility effect revisited.” Journal of Portfolio Management 46(2), 45-63.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.



1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

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. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click the “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree