Low Risk Stocks Outperform within All Observable Markets of the World

[MachineGhost]

The fact that low risk stocks have higher expected returns is a remarkable anomaly in the field of finance.  It is remarkable because it is persistent – existing now and as far back in time as we can see.  It is also remarkable because it is comprehensive.  We shall show here that it extends to all equity markets in the world. 3  And finally, it is remarkable because it contradicts the very core of finance:  that risk bearing can be expected to produce a reward.

http://www.lowvolatilitystocks.com/wp-c ... erform.pdf

[One day at a time]

Fascinating article.  I know CraigR has pointed out the potential problems in identifying volatility, ie. what was volatile yesterday may not be tomorrow.  But certainly, the idea appeals to the PP mindset.

[One day at a time]

Rob Arnott on using a low volatility strategy as part of a risk budget:

http://www.rallc.com/ideas/pdf/fundamen ... ilemma.pdf

[TK3]

Another article in support of low beta.  With the absolute outperformance of low-beta over high volitility, I have switched my stock piece to SPLV which has two beneifts, I sleep even better at night with the stock portion of my PP, and I think my absolute PP returns may be better. 

http://portfolioist.com/2012/08/02/sect ... -stocks-3/

[Reub]

SPLV only gained half of VTI today on a very good stock market day.

[MachineGhost]

Another article in support of low beta.   With the absolute outperformance of low-beta over high volitility, I have switched my stock piece to SPLV which has two beneifts, I sleep even better at night with the stock portion of my PP, and I think my absolute PP returns may be better. 

http://portfolioist.com/2012/08/02/sect ... -stocks-3/

Does that make sense when the PP allegedly relies on volatility capturing?  I've asked in here before, but I never saw a definitive answer as to how much the equity volatility capturing added to the overall portfolio.  Unless a stock picking strategy can make at least that...

I thnk the PP can either be a hedge for all economic environments or a volatility capturing portfolio, but not necessarily both at once.

[TK3]

I struggled with that point myself.  From an overall perspective the PP overall has great low-beta, low-volatility characteristics.  The studies that have come out recently, however, are discussing the low beta stock phenomenon as "the greatest anomaly in finance".  We have all been programmed to think that buying and holding more volatile stocks over the long run( and being willing to deal with what goes along with that) will lead to greater performance in the long run.  It appears now that this is not true.  Many PP followers are attracted to the permanence of the portfolio construction and holdings.  There are now low cost low beta ETFs which deserve consideration as a core holding. 

[rickb]

I thnk the PP can either be a hedge for all economic environments or a volatility capturing portfolio, but not necessarily both at once.

The 3 volatile components each are picked specifically because they're sufficiently volatile to carry the entire portfolio during times when they're going up - allowing the PP to be a hedge for all economic environments.  After periods of significant outperformance, rebalancing captures the benefit of this outperformance resetting the portfolio to its market neutral stance.  These two aspects of the portfolio seem like two sides of the same coin to me, meaning you really can't have one without the other.  Lowering the volatility of any of them would decrease its ability to carry the portfolio when it is outperforming, counterintuitively increasing the risk.

[AgAuMoney]

I thnk the PP can either be a hedge for all economic environments or a volatility capturing portfolio, but not necessarily both at once.

The 3 volatile components each are picked specifically because they're sufficiently volatile to carry the entire portfolio during times when they're going up - allowing the PP to be a hedge for all economic environments.  After periods of significant outperformance, rebalancing captures the benefit of this outperformance resetting the portfolio to its market neutral stance.  These two aspects of the portfolio seem like two sides of the same coin to me, meaning you really can't have one without the other.  Lowering the volatility of any of them would decrease its ability to carry the portfolio when it is outperforming, counterintuitively increasing the risk.

I think that is exactly correct.

The PP, being composed of 3 volatile but typically uncorrelated segments, is in itself non-volatile because of its composition.

Thus I see no contradiction between better performance with low volatility stocks, volatility capture, and the permanent portfolio.  All three of those are just different ways of looking at / accomplishing the same thing -- enhanced returns thru low volatility.

Nobody has said that every low volatility stock will outperform every highly volatile stock.  Nor have they said that low volatility will outperform on your desired schedule.  These studies really have no concrete application to the construction of a permanent portfolio (HB long ago abandoned the idea of trying to find high-volatile stocks and decided the broad-based index was just as good).

But what the studies do show, is that the conventional wisdom since the 1960's, embodied in the efficient market theory and the resulting efficient frontier, is hogwash.  Risk and reward do not have the positive correlation required by EMT.  Period.  There have been many studies over the past 50 years which show this.  But it means the entire financial planning industry doesn't have their pretty formulas to hang their hats and professors don't have a bunch of predictive math to earn grants, so such studies are not terribly popular in industry or academia.

Such is life.  Stick with the PP.  That isn't popular with industry or academia either.

[stone]

What seems bizare to me is that you still see stuff about it being anomalous how low volatilty stocks outperform and yet "the market" evidently knows very well that an ocillating price is kind of the same thing as a dividend stream so long as you capture that volatilty by rebalancing or writing call options or whatever. 
The two miners, BHPBilliton and RioTinto give a neat comparison. They conduct more or less identical business AFAIK but Rio Tinto is much more indebted than BHPBilliton and so it has more volatilty and lower dividend yield. My guess is that investment banks agitate at shareholder meetings in order to get companies to adopt a capital structure like that of RioTinto rather than that of BHPBilliton. Dividends go to all the shareholders in proportion to the shares owned. Volatility entirely passes by classic "buy and hold" shareholders (such as pension funds) with all of that potential instead passing through and being harvested by effective volatility capture shareholders such as the investment banks.

[AgAuMoney]

What seems bizare to me is that you still see stuff about it being anomalous how low volatilty stocks outperform and yet "the market" evidently knows very well that an ocillating price is kind of the same thing as a dividend stream so long as you capture that volatilty by rebalancing or writing call options or whatever.

Yup.

low-volatility performance is antithetical to the efficient market theory and modern portfolio theory.  The true believers in those theories are always shocked to discover the "anomaly" that does not conform and they are certain it is an anomaly so they quickly forget it only to later be shocked again.

EMT says that everything is known and pricing is always market perfect because markets are so efficient -- no rational way to capture volatility there.

MPT, based on EMT, says that returns are always positively correlated with risk, and risk is equal to volatility, and the way you reduce volatility is thru holding broad indices for various asset classes to put risk (and hence return) on the efficient frontier where risk (volatility) is minimized for your desired return or in other words, return is maximized for your tolerable risk.  Which again leaves no room for low-volatility out performance or for most volatility capture because volatility is all hidden inside those broad market indices.  It does allow some volatility capture as long as asset class correlation remains low or negative, but that is not an objective and given the high correlation typical of MPT portfolios, is of little benefit.

[atrchi]

I think this just exposes the biggest flaw in the EMT, which is, the concept that all market participants have the same reaction to price movements.

Low-volatility only has a superior return if you buy-and-hold. Clearly the study just proves buy-and-hold is not the best way to handle price signals.

[melveyr]

One argument is that high volatility stocks are perpetually overvalued because bullish traders want the leverage without the risk of a personal margin call. It's usefulness as a trading vehicle for bulls could cause it to trade at a premium to its "efficient" value. I'm sure someone could poke a whole in this though