2010 to 2019 was full of surprises. At the start of the decade, in the aftermath of the worst market crash since the 1930s, most investors had little hope and no expectation of the returns that subsequently followed . On average, global markets rose by an annual rate of 10%. But that wasn’t all.
The past decade also saw the spectacular rise of FAANG and BAT stocks. US stocks outperformed all other regions by a wide margin and the growth investment style outperformed value. Most importantly, both equity and bond markets rose simultaneously, leading to attractive returns for all balanced portfolios. Finally, because returns were high and equity market volatility was generally low, the resulting return/risk ratio was particularly strong, especially for US stocks.
In this context, the past decade also proved to be remarkable from a factor performance perspective. Generally speaking, it was the best decade in recent history for low volatility, offering the highest return per unit of risk. This was the case in global markets, US markets and emerging markets but not in Europe.
In Europe, momentum was the winner, both in terms of absolute and risk-adjusted returns, followed by the low volatility factor. Moreover, momentum delivered the highest absolute return in other regions. Meanwhile, value generated the lowest return and also the lowest return per unit of risk in all regions. For value investors, the decade was more like the ‘terrible tens’ than the ‘terrific tens’.
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Over the past few years, many parallels have been drawn between the 1990s and the 2010s. For instance, the fact that momentum was the strongest factor in both decades. Yet value didn’t struggle as much in the 1990s, outperforming the market as well as the low volatility, high dividend and small caps factors. In fact, the 2010s were much closer to the 1930s.
Just like in the 2010s, the value style also came last in the 1930s, while momentum had a strong run. Moreover, the recovery seen in the 2010s, after a severe global stock market crash, echoes the recovery of the 1930s. However, unlike the 2010s, the 1930s were characterized by low returns and high risks, an environment in which low volatility stocks tend to perform well relative to other styles.
The low volatility factor is alive and kicking, clearly showing its added value in the past decade, especially when adjusted for risk
So the low volatility factor is alive and kicking, clearly showing its added value in the past decade, especially when adjusted for risk. In fact, when compared to a set of other factors, including value momentum, size and high dividend, the low volatility factor came out as the strongest factor of the last nine decades, with the highest return/risk ratio of all factor styles (see Figure 1).
But if the 2010s can be likened to the 1930s, should we expect the 2020s to resemble the 1940s? Should low volatility investors be worried? Indeed, during the 1940s, markets rose sharply. And while the value factor delivered a very strong performance, low volatility lagged the market and all other factors. During this period, low volatility stocks were expensive, just as they are now.
Yet stocks featuring a smart combination of low volatility, high net pay-out yield and positive momentum still managed to comfortably beat the market during the 1940s and 1950s, despite the focus on lagging low volatility stocks. This illustrates the importance of enhanced factor strategies that take into account multiple complementary signals.
This also supports the investment process of our Conservative Equities strategies, which select low-risk stocks with a high income, attractive valuation and positive momentum, among other characteristics.
For the coming decade, we expect this enhanced approach to low-risk investing, which combines multiple complementary signals, to become even more relevant than during the past decade. In particular, taking valuation signals into account could prove critical, as the value factor could make a comeback, after a lackluster previous ten years.
Seven years ago, we wrote a paper on the performance of low volatility stocks in periods when they were more expensive than the market, which mostly occurred during the 1940s and 1950s. We argued that an enhanced low volatility strategy can offer a measure of protection from this kind of scenario. And we still stand by this argument today.