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Why not all low-volatility stocks are equal

Why not all low-volatility stocks are equal

15-09-2014 | Insight

Low-volatility investing is becoming more popular. Many professional investors currently explicitly allocate a significant portion of their portfolio to low-volatility stocks. Robeco uses an enhanced approach to increase returns and reduce risk.

  • Pim  van Vliet, PhD
    van Vliet, PhD
    Portfolio Manager and Co-Head of Robeco’s Quantitative Equities department
  • Arlette van Ditshuizen
    van Ditshuizen
    Portfolio Manager and Co-head of the Quant Equity Portfolio Management team

Speed read

  • Robeco employs an active approach to low-volatility investing called the Conservative Equity strategy. 
  • We applied our philosophy of not going against other factors when selecting low volatility stocks. 
  • For most investors, preservation of capital is more important than concentrating on benchmarks. 
  • Robeco researches in house with its own data to ensure quality. 
  • Focus has shifted to explaining how Robeco Conservative Equities is different from other strategies.

Robeco was one of the first asset managers to adopt low-volatility equity investing in 2006. When we started we were among just a handful of low-volatility forerunners worldwide and have since played a major role in not only managing money but in contributing in this complex field - for example, by researching and writing many academic papers on the concept. 

Robeco employs an active approach to low-volatility investing. This approach is called the Conservative Equity strategy, which is applied to global markets and several regions. Interestingly, the low-volatility effect isn’t limited to equities. Robeco successfully offers a similar strategy for credits. Our Conservative Credits strategy invests in bonds with a shorter-than-average maturity from issuers with below-average distress and seniority risk. Besides several low volatility strategies, Robeco also offers momentum and value strategies. All these strategies are aimed at segments of the market with superior risk and return characteristics. Combining these strategies offers excellent diversification prospects. Strategically allocating to these factors is called factor investing. 

‘Active approach to low-volatility investing’ 

Although we were early contributors to the field of low-volatility investing, interest only really started to grow as a result of the increased need for caution among investors during the global financial crisis of 2008-09. This period demonstrated just how volatile markets can be. The advantage of Robeco’s Conservative strategy is that, in a declining market, the stocks involved typically fall less than other stocks. Once the market recovers, low-volatility stocks have less ground to make up to recover and start yielding positive returns again. Our strategy aims to reduce volatility by 20 – 30%. 

The Robeco Conservative Equities approach, which focusses on low-volatility stocks, neatly combines prudency with innovation, and it has proved its worth in the eight years since it was launched. The strategies have a strong track record compared with low-volatility and market-cap weighted indices. And the anomaly still holds, even though low-volatility investing is becoming more popular. 

The Conservative approach is based on a revolutionary concept: risk and return do not go hand in hand. The strategies capitalize on one of the first anomalies to be researched: the low-risk anomaly. Stocks with low beta or low volatility realize higher returns than can be explained using the Capital Asset Pricing Model. This anomaly has been proven, not only in the United States, but also in Europe, Japan and emerging markets.

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Challenges of innovation

“When we first started, the challenge was how to convert the low-volatility factor, or anomaly, into an efficient portfolio,” says Pim van Vliet, portfolio manager of Robeco Conservative Equities. “Because in the end, not all low volatility stocks are equal, so we want to select the most attractive ones. Why should you hold a stock that is gradually going down – one that has low volatility but negative momentum in an up market?” 

“Therefore we applied our philosophy of not going against other factors such as momentum and value when selecting low volatility stocks. We also wanted to see how we could limit portfolio turnover. We continued to enhance the model throughout the years. Our investment philosophy and process have contributed to our performance in terms of risk and return.” 

‘Our philosophy of not going against other factors’ 

And there were other challenges to overcome. “The pioneering part was also explaining the concept of low volatility-investing. What is it and how does it fit into an investor portfolio? It took several years before low-volatility was accepted by some leaders in the global investment community,” he says. ‘’Explaining the concept to clients gave us a better idea of how the strategy fitted their needs.”

Prudency is the starting point

Van Vliet’s colleague, Robeco Conservative Equities portfolio manager Arlette van Ditshuizen, stresses another aspect of innovation. “Prudency is the starting point for our strategy, she says. “The visionary part was the fact that our strategy did not track indices closely. When we started out, instead of focusing on relative risk, we looked at absolute risk, while the whole finance industry was concentrating on benchmarks.” 

“But closely following a benchmark isn’t necessarily in clients’ interests. For both individual and professional investors, preservation of capital is more important,” she adds. “For professional investors, such as pension funds, our focus on lower risk is also attractive because it can help stabilize funding ratios.” 

Van Vliet points out that prudency isn’t just part of the strategy, it’s also part of the Robeco culture. “Take for example, our focus on a low portfolio turnover. On average, a stock is held in the portfolio for four years. We want our turnover to be as low as possible in order to minimize trading costs. These costs directly eat into net performance.” 

“Our low turnover approach is contrary to how most people perceive quantitative investing. Quant is often associated with high frequency trading and high trading costs, but this is not necessarily the case.” 

‘We want our turnover to be as low as possible’ 

“Another part of our culture when coming up with new ideas is simplicity. We try to keep things as simple as possible, while sometimes others see complexity as a means of showing how smart you are. Complexity is only relevant if it leads to better results.”

Importance of in-house research

Van Ditshuizen stresses the importance of conducting your own research: “We research everything in-house. We want our own data so we can check to ensure the quality is good. Furthermore, we take many different aspects into account, when we look at the effectiveness of a certain variable. We evaluate and weigh up what is most important.” We are always careful, when assessing research, she says. “Sometimes a change to the model can increase return, but also add risk. Or it can lead to a different number of stocks in the portfolio, or worse performance in down markets. I cannot imagine that it is possible to successfully outsource research, when there are so many aspects to look at. So I am very happy that our researchers are so nearby.”

Different from other low-volatility strategies

“Now the focus has shifted to explaining how Robeco Conservative Equities is different from other strategies,” says Van Vliet. “And it differs in many ways, because we add elements to decrease risk or enhance return. For example, we also take distress risk into account and move beyond backward-looking statistical risk measures. The main effect of taking distress factors into account is a further reduction in tail risk compared to a generic low-volatility strategy. Also the inclusion of value and momentum factors is an important feature, which has proven very effective over the past years.” 

He is not worried about increased competition and broader range of low-volatility products on offer. “This is a good development. Clients will have more choice. And of course we are happy that the general level of interest is increasing.” 

”Our clients tend to be loyal. We can say that after almost eight years. Many were hesitant to come on board, but once they opted for our philosophy they stayed with us,” he adds.

One of the first countries to embrace the concept

Investors might think it is surprising that the Netherlands, a small European country, is leading innovation when it comes to low-volatility investing, but Van Vliet can explain why it was one of the first countries to embrace the concept. 

“To some, this might seem surprising, but the Netherlands has two advantages. First it has a large and sophisticated pension fund sector which is at the forefront of new developments. Second, the country’s universities are amongst the global leaders in the field of econometrics. Over the past decades, Dutch universities have created a talent pool of quantitative researchers which feeds the financial sector. This is the place to be.”



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