Low Volatility Factor

Low Volatility

Worried about market fluctuations? Consider the Low Volatility factor.

In the world of factor investing, avoiding volatility has become one of the most important investment considerations. Investing in equities with the lowest volatility is the essence of low volatility investing. But how is it beneficial? Analogy from the field of cricket will be examined now.

It goes without saying that the most interesting batsmen to watch are those who have the highest strike rates. However, the sad truth is that very few of these exciting batters are reliable scorers or have high career batting averages.

Similarly, the most thrilling stocks are frequently those that rise and fall extremely dramatically. But only a small percentage of these consistently perform over time and market circumstances. The low volatility aspect comes into play here.

It's one of the easier investment criteria to use because it can be determined quickly using only the stock price across time and relative to other stocks. Also, volatility characteristics of stocks  have been found to be consistent and slow to change.

Low volatility

Low volatility stocks aren't the most interesting stocks to invest in. Their secret to making money isn't how quickly or far they rise, but how slowly they fall. They typically produce the best volatility adjusted returns, even if they don't always produce the best returns.

Does the Low Volatility Factor work?

Low Volatility Factor Work

Typically, stocks with low volatility characteristics reward investors with higher risk-adjusted returns compared to a broad market capitalisation strategy over the long term.

The benefit of using the low volatility factor became evident among institutional investors in the wake of the Global Financial Crisis (GFC) in 2008 and the Euro Debt Crisis.

In a study covering 2 decades and all stocks traded on the Bombay Stock Exchange, Agarwalla et al. find that lower volatility stocks can generate superior returns compared to high volatility stocks (Arunachalam et al., 2020, #). The authors believe that the lack of access to leverage for stock market investments encourages investors to seek higher risk stocks in an effort to achieve the highest expected return.

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