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Why Low-Volatility Funds Aren’t Worth It For Long-Term Investors
Uhhh ... Chuck asked me about these funds as he was writing the column. His email suggested that he'd already concluded that they were the wrong solution to a non-problem. In response I wrote:
The research is pretty consistent that low-vol stocks outperform (a) the broad market and especially (b) the market darlings by wide margins over time; that outperformance is very consistent in falling markets but does also occur in some bull markets as well. It looks like 100-200 bps of gain with about 25% lower standard deviation.
Why do they win? I don't know and I have rather more respect for the researchers who say "it's complicated" than for those with the smooth, neatly packaged explanations. There are two possible paths:
1. a low-vol stock portfolio is good because it invests in low-vol stocks. High dividend yield investing works because high dividend yields suggest something about the underlying business model, and something similar might be true here.
2. a low-vol stock portfolio is good because it does not invest in high-vol stocks. I like this explanation more. High volatility stocks tend to be "story stocks," drawing lots of attention and lots of eager investors. They soar and swoop. And, in general, disappoint investors either by crashing entirely or by posting miserable returns because investors paid for the story rather than for the earnings. Their mere exclusion from the portfolio solves much.
Curiously, that's the same argument made by Andrew Foster at Searfarer and the team at Guinness Atkinson: a large fraction of firms are structurally impaired, simply keeping those out of your portfolio leads to above average returns.
I have built up a nice nest egg over time and not because I am smart or skilled (actually probably the opposite) But by concentrating solely on trend persistency combined with LOW Volatility. That has enabled me to go 100% all in whatever and abstain from the diversification game. A game that while it may work, nonetheless leads to lower returns than a concentrated portfolio.
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David