Low beta investing
Low beta investing (also called "low volatility investing") involves investment in stocks that have lower volatility than the market in an attempt to get higher returns, or the same return with less risk.[1] The strategy has worked in the past,[2] but whether the low volatility anomaly will persist in the future is uncertain.
Background
The term "beta" comes from the development of the capital asset pricing model (CAPM) in the 1960's. In short, this model theorized that investors should be rewarded for purchasing stocks that had a higher volatility (and, thus according to the model, a higher risk) than the market as a whole. The volatility was captured mathematically by a calculation called beta. The calculation of beta depends upon the measurement interval.[3]
Unfortunately for the model's proponents, further research[4][5][6] suggested that excess returns over the market could be obtained by purchasing low-beta stocks instead of high-beta ones. This anomaly has been found to extend to all observable world markets.[2] Note that some researchers distinguish the "low beta anomaly" from the "low volatility" anomaly.[7]
Additionally, some investors favour low volatility stocks because they are uncomfortable with high volatility holdings.
Explanations and risk factors
Behavioral explanations of why low volatility investing has worked in the past have been given, such as the ‘preference-for-gambling hypothesis’.[8]
Other explanations of the low volatility anomaly are that the low-beta stocks tend to be value stocks, or that low volatility portfolios have different industry weightings and so are in essence ‘industry bets’.[9]
Swedroe looked at some US low volatility funds in 2015 and found that they had P/E ratios and P/B ratios higher or equal to that of a market-oriented fund. In other words, they now have a growth tilt, not a value tilt. He attributes this to "the popularity of the strategies, leading to large cash flows".[10]
A comparison of two exchange-traded funds (ETFs) covering Canadian equities offered by BMO, a low volatility one (ZLB) and a broad market one based on the S&P/TSX Capped Composite Index (ZCN), also shows a growth tilt for the low volatility strategy. As of December 31, 2015, the low volatility ETF had a higher P/B, and a lower dividend yield (the P/E values were the same). The Morningstar style boxes were 'Large core growth' for ZLB and 'Large core' for ZCN.
Using specialized ETFs
Low-beta stocks are targeted[11][12] by several ETFs. These ETFs are designed to smooth the ride for risk-adverse clients, but take the time to understand the strategy. Whatever low-volatility ETF you select, it's important to understand that these strategies really are nothing more than quantitative active strategies. So, make choices based on a deep understanding of the strategy and conditions that will cause your choices to excel or falter.[13]
For Canadian equities the following low-beta ETFs are available on the TSX:
For US equities the following low-beta ETFs are available on the TSX:
For International equities the following low-beta ETFs are available on the TSX:
The management expense ratios (MERs) for such funds are typically much higher than those of plain-vanilla ETFs.
Stock picking
Where to find beta
Some stock market quotation sources such as TMX and Globeinvestor provide beta with their stock quotes, although the values quoted may differ because of differences in methodology. A low volatility index has been introduced by the S&P/TSX.[14] The ETFs listed above contain low volatility stocks and can be checked for stock picking ideas.
Types of stocks
Low-beta stocks can be identified from the ZLB, TLV, and XMV holdings, and typically include consumer staples, power generation, and telecommunications. The TLV holdings also include several REITs.[15]
See also
References
- ^ Blitz D, van Vliet P (2007) The Volatility Effect. Journal of Portfolio Management, v. 34, p. 102-113, doi:10.3905/jpm.2007.698039, PDF available on SSRN
- ^ a b Nardin L. Baker and Robert A. Haugen, Low Risk Stocks Outperform within All Observable Markets of the World, SSRN, April 27, 2012.
- ^ "Gummy", "Beta here Beta there", "Gummy Stuff", viewed Feb. 2, 2012.
- ^ Malcolm Baker, Brendan Bradley, and Jeffrey Wurgler, Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly, Financial Analysts Journal, Volume 67, Number 1, p.40 (2011).
- ^ Jeff Benjamin, Surprising new research indicates that greater risk does not, in fact, lead to greater reward, Investment News, April 19, 2012.
- ^ Erik van Dijk, The Low Volatility, Low Beta Anomaly, Seeking Alpha, October 24, 2011.
- ^ Cazalet Z, Roncalli T (2014) Facts and Fantasies About Factor Investing. Available on SSRN.
- ^ Feifei Li, Making Sense Of Low Volatility Investing, February 21, 2013, viewed January 19, 2016
- ^ Larry Swedroe, A way to get stock-like returns with less risk?, August 2, 2012, viewed January 19, 2016
- ^ Larry Swedroe, Be Wary Of The Low Vol Factor, February 13, 2015, viewed January 19, 2016; There’s a cliche in finance that success can sow the seeds of its own destruction. At the very least, investors in low-volatility strategies should be aware that the flow of cash into the strategy has changed the very nature of the funds
- ^ John Gabriel, A new ETF that exploits the low-volatility anomaly, Morningstar, viewed Feb. 3, 2012.
- ^ Preet Banerjee, These ETFs Smooth Out the Market's Wild Roller-Coaster Ride, Globe and Mail, January 20 2012.
- ^ Dan Hallett (May 2015). "Lifting the hood on low-volatility ETFs". Investment Executive., viewed January 23, 2016.
- ^ David Parkinson, Low Volatility index dominated by market’s traditionally defensive sectors – REITs, utilities and consumer staples, Globe and Mail, April 18 2012.
- ^ Financial Wisdom Forum, Low Beta Investing.
Further reading
- Financial Wisdom Forum topic: "Low-Beta Investing"
External links
- Globe and Mail, Low-volatility funds not yet ready for prime time