Low Volatility, Low Beta & Low Correlation

There is Magic in Leverage

August 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • The Low Volatility, Low Beta and Low Correlation factors are interrelated
  • Low-risk factors generate attractive risk-adjusted returns, but require beta-neutrality
  • Currently they feature moderate to high interest-rate sensitivity

INTRODUCTION

Coca-Cola versus Bitcoin Investment Trust, Mattel versus Groupon, Ventas versus Facebook. Which stocks would you prefer? These stock pairs represent low versus high volatility, low versus high beta, and low versus high correlation to the market. Most traditional stocks pickers likely consider these metrics exotic compared to evaluating stocks on their valuation or quality characteristics. Aside from the quantitative nature of these metrics, the theory that stocks with low risks outperform stocks with high risks is counterintuitive and in conflict with a classic finance education. However, given a strong performance of low-risk factors over the last two decades, these are becoming more common in portfolios. In this short research note we will investigate and contrast the Low Volatility, Low Beta and Low Correlation factors (read Low Volatility: High Factor Valuation).

METHODOLOGY

We focus on the Low Volatility, Low Beta and Low Correlation factors in the US, European and Japanese stock markets. The factor performance is calculated by constructing long-short portfolios of the top and bottom 30% of stocks ranked by the factor definitions. Low Volatility ranks stocks by their volatility, low beta by their beta to the market, and low correlation by their correlation to the market, all measured with a 12-month lookback period. Only stocks with a minimum market capitalisation of $1 billion are included. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.

NET BETAS OF THE LOW VOLATILITY, NET BETA & LOW CORRELATION FACTORS

Investors musing about Coca-Cola (KO) versus the Bitcoin Investment Trust (GBTC) are naturally aware of the different risk profiles. Coca-Cola is a stable, mature business selling flavoured drinks in over 100 countries and counts Warren Buffett as a shareholder. The Bitcoin Investment Trust provides investors exposure to Bitcoin, which is highly volatile, and has