Such a recommendation is not merely academic. In recent years, MSCI and S&P have introduced low-volatility indexes. Where there are indexes, it seems, ETFs will follow. PowerShares S&P 500 Low Volatility ETF, for example, which was launched in May 2011, has over $3 billion in assets. Thus, advisors can easily add low-volatility equities to clients’ portfolios.
As Li shows in her article, low volatility portfolios have produced higher returns with less volatility than traditional large-cap portfolios over the past 5, 10, and 20 years. This phenomenon can be seen in the U.S. and in other developed nations’ stock markets. During Li’s sample period, from mid-1991 to early 2012 (over 20 years), the S&P Low Volatility Index returned 10.2% a year, vs. 8.7% a year for the S&P 500. Among foreign equities, the gap was even larger.
In both the domestic and foreign comparisons, the low volatility stocks were also less volatile, resulting in much higher Sharpe ratios. “In addition,” Li pointed out, “low volatility portfolios have average correlations of 0.4–0.5 with other major asset classes, whereas traditional large-cap equity strategies have average correlations above 0.6.” Reduced correlation may smooth out overall portfolio performance.
Li’s data show that low-volatility stocks lagged badly in the dot-com boom of the late 1990s. However, that has not been the case for all bull markets: low-volatility stocks had superior results from 2003 through 2006, when the foreign index returned nearly 30% a year. Altogether, Li concludes that “adding low volatility strategies is likely to result in greater diversification and a more attractive final portfolio for investors.”
