Don't Count Out the Low-Volatility Factor

The strategy’s alpha cannot be “dismissed as another manifestation of the value effect,” says Robeco Asset Management’s top quant.

Low-volatility strategies carry a distinct premium unrelated to the value effect, research has shown.

While there is a strong overlap between low-volatility and value investment strategies, the performance of low-volatility portfolios cannot be entirely explained by the value factor, argued David Blitz, co-head of quantitative strategies at Robeco Asset Management.

“The low-volatility effect is a distinct phenomenon which cannot simply be dismissed as another manifestation of the value effect,” Blitz wrote.

For the study, Blitz constructed low-volatility portfolios over a period from 1929 to 2014, and compared their performance with that of the value factor as defined by Eugene Fama and Ken French. He found that value explained the performance of only the large-cap segment of the market, and only between 1963 and 1984.

“The performance of low-volatility strategies can only be explained by the value effect if we specifically consider the large-cap low-volatility strategy, over a specific period of about 20 years in the middle of the 86-year long sample period,” Blitz wrote.

Meanwhile, consistently high Sharpe ratios for both large-cap and small-cap low-volatility strategies “confirms the existence of a low-volatility effect,” Blitz argued. Equally weighted low-volatility portfolio returns were also consistently higher than value-weighted low-volatility returns.

“The economic rationale behind the two effects seems to be entirely different,” Blitz wrote.

In order to unlock the full potential offered by the low-volatility effect, Blitz said investors should consider equal-weighting rather than value-weighting large-cap low-volatility portfolios. Additionally, he recommended seeking exposure to low-volatility small-cap stocks.

“Instead of choosing between harvesting either the value premium or the low-volatility premium, investors should simply benefit from both,” Blitz concluded. “During prolonged periods of time when one factor fails to deliver, the other factor can provide relief.”

Read the full paper, “The Value of Low Volatility.”

Related: Should You be Worried about a Low Volatility Bubble?