Frequently the question comes up if low-volatility is ‘expensive’, measured by multiples such as P/E and P/B ratios. The investors asking this are sometimes worried about the expected performance of low-volatility in such an environment. In this note, we address this question using an extended 82-year sample period for the US stock market.
We find that a generic lowvolatility strategy sometimes exhibits value (1990s) and sometimes growth (1930s) characteristics. An enhanced low-volatility strategy, which includes valuation and sentiment factors, yields a much better return/risk ratio than a generic low-volatility strategy and is necessary to achieve superior long-term returns.
Recently, the P/B ratio of a generic low-volatility strategy has become relatively high again. Historically, generic low-volatility underperforms the market in such an environment, but proves effective to lower the risk. An enhanced low-volatility strategy is particularly helpful when generic low-volatility is expensive and improves the return of a generic low-volatility strategy by up to 6% per year.
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