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This paper replicates various low volatility strategies and examines their historical performance using U.S., global developed markets, and emerging markets data. In our sample, low volatility strategies outperformed their corresponding cap-weighted market indices due to exposure to the value, betting against beta (BAB), and duration factors. (The duration factor introduced here is new to the low volatility literature.) The reduction in volatility is driven by a substantial reduction in the portfolios’ market beta. For long-term investors, low volatility strategies can contribute to a more risk-diversified equity portfolio which earns equity returns from multiple premium sources instead of market beta alone. Nonetheless, while the lower risk and higher return seem persistent and robust across geographies and over time, we find flaws with naive constructions of low volatility portfolios. First, naive low volatility strategies tend to have very high turnover and low liquidity, which can erode returns significantly. They also have very concentrated country/industry allocations, which neither provide sensible economic exposures nor find theoretical support in the more recent literature on the within-country/industry low volatility effect. Additionally, there is concern that low volatility stocks could become expensive, a development which would eliminate their performance advantage. Portfolio construction methods should be sensitive to valuation levels and investability. |
