Is Low Vol the New Value?

Same, Same, but Different

September 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • The Low Volatility factor exhibited significant exposure to Value since 1989
  • The factors were highly correlated in the 1990s, but less after the financial crisis
  • Quantitative easing was positive for Low Volatility, but negative for Value

INTRODUCTION

Riding the Ferris wheel in an amusement park is the equivalent of investing in a Low Volatility strategy in the stock market. It is all about experiencing a smooth ride with no hidden surprises that might affect the emotional well-being of the theme park visitor. In contrast, taking a roller coaster ride is like being a Value investor. It will be rough and scary, but hopefully worthwhile once on solid ground again.

However, although investors pursuing a Low Volatility strategy seem to have asymmetrical interests to Value investors, the underlying portfolios are not always that different. For example, the technology sector contributes a meaningful amount of stocks to the short portfolios of both factors as tech stocks are typically volatile and expensive.

The most significant difference for investors has likely been the performance in recent years. Value generated negative returns in nine out of the last ten years while Low Volatility has been leading the factor scoreboard almost every year (read Improving the Odds of Value: II).

Although this would include a healthy dose of performance chasing, investors might question if the two factors are similar enough to replace Value with Low Volatility in investment portfolios?

METHODOLOGY

We focus on the Value and Low Volatility factors in the US stock market. The factor performance is calculated by constructing long-short beta-neutral portfolios of the top and bottom 10% of stocks ranked by their factor definitions. Only stocks with a minimum market capitalization of $1 billion are included. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.

FACTOR EXPOSURE ANALYSIS

First, we conduct a regression-based factor exposure analysis of the long-short Low Volatility factor in the US stock market to detect if there is any relationship with o