How to verify the Volatility Anomaly in global equities?
A lot of research shows that low volatility portfolios tend to outperform cap weighted indexes over a full cycle in equity markets. Setting up a minimum volatility strategy to check this takes a lot of effort, but the performance characteristics of low volatility stocks are in the open. Low risk portfolios are outperforming broad market indexes, and the volatility anomaly is easy to find.
Let me explain how we can verify the “Volatility Anomaly” I presented in my last blogpost.
In my view, the simplest way of testing this, is to rank stocks on volatility. Then make some portfolios based on the ranking and check the portfolio returns. It is something you could do in a spreadsheet. All you need is performance for a significant set of stocks over some period.
Here's an example:
A test of our strategy on the US equity market
Let’s do this test on the biggest equity market, US equities. The test is simple; Take the largest 3,000 companies in the US. Every month, we rank them on last two year volatility, and create 10 portfolios. Portfolio 1 holds the 300 lowest risk stocks, and portfolio 10 holds the 300 highest risk stocks.
Then we calculate returns for these 10 portfolios, and iterate this process over a significant period of time. Calculating annual returns for the period January 2000 – November 2019 shows these results:
Remember that these portfolio do not have any constrains on turnover. There are no trading costs or management fees. But really, these differences are rather large. The source of this analysis is our “Systematic Active Equity” web analysis. We do such analysis for more than 50 company fundamentals/characteristics, and the low volatility anomaly remains one of the most effective simple ways of ranking stocks. We do this for about 40 different markets around the world. The above result is not very surprising.
A crowded space, it is too late now?
Critics say that “the world is new”, this anomaly has been priced out by investors a long time ago. Well, it is true that professionals have known this for some time. But what if we do the same analysis as above since January 2014?
