Over the last few years, investors have been piling money into low-volatility investments – stocks and funds that are designed to move up and down less than the overall stock market.
These investments, often defensive stocks, like grocery stores and utilities – companies that can do well in any market environment – fluctuate less than other companies, like technology or mining operations.
It’s not a new idea, but it’s one that’s been picking up steam. “The idea of low-volatility investing has been around for years, but it gained momentum during the financial crisis,” says Les Grober, Senior Vice-President and Head of Asset Allocation for Investors Group.
With some people worried about eight-years of stock market gains reversing, others concerned about how geopolitics might impact their portfolios and many people just wanting to be prudent investors, low-volatility funds should only see more growth in the future.
Fewer movements, but more returns
While much of the literature around low-volatility funds is around their ability to minimize ups and downs, research shows that these types of investments tend to outperform more volatile stocks, says Sam Pellettieri, Portfolio Manager, Quantitative Research for Investors Group.
“Five decades worth of studies provide strong evidence that low-volatile stock portfolios earn solid, risk-adjusted returns,” he says. “We did our own homework and, we found that low-vol strategies had superior risk adjusted returns to the broad markets and especially versus high risk, high volatility stocks.”
According to Investors Group’s research, low-volatility investments do indeed have better risk-adjusted returns than other investments. (Risk adjusted return measures the amount of return you get for the level of risk you take. The higher the number, the better.)
It found that the Sharpe Ratio, which is the ratio that measures risk-adjusted returns, on low volatile stocks is 0.88 compared to 0.04 for a higher volatility stock. That indicates that the stock with lower volatility provides a better return relative to its riskiness, than the higher volatility one.
If you look at the entire universe of stocks, the Sharpe Ratio is 0.54%, so lower volatility beats the broader market on a risk and return basis, too.
Despite these findings, many low-volatility stocks are less popular than higher volatility ones, because people still want the hot stock that could provide a short-term gain. That’s fine with Grober and Pellettieri as the lack of attention has made low- volatility stocks less expensive than their higher volatility counterparts.
“A focus on trying to pick winners can lead investors to ignore the least volatile stocks because they are unlikely to deliver a large payout in the short term,” says Grober. “So those stocks tend to be undervalued resulting in outperformance over the long term.”
Add low-volatility to your portfolio
Given the risk-return profile for these funds, adding some into a portfolio is something investors may want to consider doing.
Grober, who oversees Investors Group’s Maestro Portfolios, mutual funds made up of other funds, including low-volatility ones, says that his portfolios are ideal for people who want exposure to higher growth stocks, but also want to own a portfolio that experiences less ups and downs than the broader equity markets.
As well, owning these kinds of funds is especially important now, as rising yields could cause fixed income prices to fall.
“You should certainly consider these funds if you have concerns with the current fixed income environment and are interested in a higher strategic weighting in equities, but without the associated risk that is typical of more traditional equity funds,” he says.
Solutions like the Maestro Portfolios, which turned two in July and have over $5 billion in assets under management, offer exposure to both growth equities and lower volatility stocks at the same time.
“Maestro Portfolios are designed and managed to move in response to movements in global financial markets,” he says. “That flexibility and the strategic inclusion of low-vol investments allows us to have a greater equity weighting across each portfolio without increasing the overall risk profile.”
Considering that most investors simply want to sleep well at night and not have to worry about market swings, it’s no wonder that the popularity of low-volatility securities are on the rise.
“You get greater diversification benefits,” says Grober. “And that means you’ll have smoother ride.”
This commentary is published by Investors Group. It represents the views of our Portfolio Managers, and is provided as a general source of information. It is not intended to provide investment advice or as an endorsement of any investment. Some of the securities mentioned may be owned by Investors Group or its mutual funds, or by portfolios managed by our external advisors. Every effort has been made to ensure that the material contained in the commentary is accurate at the time of publication, however, Investors Group cannot guarantee the accuracy or the completeness of such material and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein.