Factor/Style Investing
Low-Volatility Cycles: The Influence of Valuation and Momentum on Low-Volatility Portfolios
June 1, 2015
Topics - Factor/Style Investing Equities
In what is often referred to as the “low-volatility” anomaly, researchers have shown that measures of prior stock price variability relate to future performance but not necessarily in the way theory suggests. Theory indicates that investors demand higher returns as compensation for higher expected risk. Researchers, however, have found that, empirically, the lowest-risk stocks tend to outperform the highest-risk stocks.
The finding of a negative risk-return trade-off contradicts the most basic principle of financial economics and has had a dramatic impact on the theory and practice of investment management. In practice, investors have seen an explosion of strategies designed to “take advantage” of the outperformance of low-volatility stocks.
Our analysis of all stocks that traded on NYSE, AMEX and NASDAQ from 1968 through 2012 suggests that so-called low-risk stocks tend to outperform high-risk strategies in the future only when initial valuation levels and positive momentum favors low-risk stocks. In other words, investment success depends importantly on the price paid. The challenge to low-risk investing, common to any successful investment strategy, is therefore to identify “cheapness” and positive momentum ex ante.
We have shown that there have been periods of time over the last 85 years during which high-risk stocks cumulatively outperform low-risk stocks. These periods tend to have coincided to some degree with economic cycles. Although one should be wary of making predictions based on past events, our findings suggest the performance of low-beta stocks depends on a number of important macroeconomic, market and valuation factors.
This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.