A recent study has concluded that investments that have higher volatility generate lower returns for investors. For many years, it has been a basic precept of modern portfolio theory that the price of opting for lower risk is lower reward. That is bunk, according to Robert Haugen, a former professor of finance at the University of Wisconsin and current president of a firm that produces quantitative investment research for subscribers. “We found that in every one of the world’s markets, higher volatility equals lower returns,” Mr. Haugen was quoted as saying, adding: “Does this fly in the face of modern portfolio theory? You’re damn right it does.” (See “Less risk offers more reward, study finds,” InvestmentNews).
From 1990 to 2011, in every stock market in the world, the least volatile stocks outperformed the most volatile stocks by 17 percentage points, on average, according to Mr. Haugen. With regard to U.S. equities, the least volatile 10% of stocks returned an average gain of 12.2% over the same period, while the most volatile 10% declined by 8.8%.
Russell Investments launched two exchange-traded funds that separately track the least volatile and most volatile stocks in two broad market indexes. They were launched on May 27, 2011; thus they have less than one year’s performance data. The Russell 1000 Low-Volatility ETF (LVOL) gained 5% from its launch through April 17, while the Russell High-Volatility ETF (HVOL), declined by 4%. The Russell 2000 Low-Volatility ETF (SLVY) gained 2.6% over the same period, while the Russell 2000 High-Volatility ETF (SHVY) declined by 15.3%.
According to the article, 50 plus years of research shows that stocks with lower beta, or market correlation, over the long term consistently outperform stocks that are more highly correlated to market risk.
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