The low volatility factor is based on the idea that stocks with lower volatility have a tendency to outperform stocks with higher volatility. This is often referred to as the "low volatility anomaly" because it goes against the common assumption that higher risk should lead to higher returns. To construct the low volatility factor, investors can create a portfolio of low volatility stocks and compare their performance to a portfolio of higher volatility stocks. The low volatility factor has been shown to be consistent over time, present in different countries and asset classes, and can be actively harvested by quantitative investors.
Factor Research
The performance of the low-volatility factor compared to the value factor has varied over time. In the past, the low-volatility factor has generally outperformed the value factor, with a higher average return and lower volatility. However, in recent years, the value factor has had a strong performance, outpacing the low-volatility factor. It is important to note that the performance of a factor can vary over time and may not always outperform other factors. It is important for investors to consider the potential risks and rewards of each factor when constructing an investment portfolio.
Reasons
Low-volatility stocks have been shown to produce better risk-adjusted returns compared to high-volatility stocks, a phenomenon known as the low-volatility anomaly
The low-volatility factor is a defensive factor that has been shown to help overall portfolio performance during market drawdowns
Hypotheses for the existence of the low-volatility anomaly include the lottery effect, constraints on fund managers' use of leverage, incentives for fund managers to beat benchmarks, and investor behaviour towards news-worthy or attention-grabbing stocks
Low-volatility strategies have done well during periods of quantitative easing and steady, consistent asset price growth
When does low vol do well?
However, it is important to note that low-volatility is not a consistently strong performer in all market environments. During times of market exuberance and strong economic growth, low-volatility stocks may underperform as investors seek out higher-risk, higher-return opportunities. Additionally, low-volatility stocks are often concentrated in defensive sectors such as utilities and consumer staples, which may not perform as well in a rapidly growing economy. It is important for investors to consider the current market environment and economic conditions when evaluating the potential performance of a low-volatility strategy.