Low volatility

Low volatility – or “low vol” – investing means buying shares (or bonds) that tend to go up or down in price by less than the overall market (in other words, they’re less volatile).

In theory, low-volatility assets should deliver lower returns than highly volatile ones, because investors are supposed to demand extra rewards for taking extra risks. Yet in fact, studies show that low-vol stocks beat their higher-volatility peers over time. As a result, low vol has been marketed as a “factor” – alongside value, small-cap and momentum investing – that can help investors to beat markets over the long run.

Low vol has grown particularly popular in the wake of the 2008 financial crisis, after which the idea of being able to invest in “low-risk” assets and still beat the market became understandably attractive to jittery investors. The PowerShares S&P 500 Low Volatility exchange-traded fund now holds more than $7.4bn in assets under management, for example. As a result, some argue that the factor may no longer be as effective in the future.

For example, Larry Swedroe has argued on ETF.com that one reason for low vol’s outperformance is that, historically, low vol stocks have also been value stocks – they’ve been cheap. Given the amount of money that has been drawn to the sector, that’s no longer the case – so it’s possible that low vol will not outperform in the future.

Another concern about today’s particularly calm investment environment is that many wider investment strategies now depend on volatility remaining low and falling – in effect, many investors are “short volatility”, whether they fully realise it or not. As a result, if volatility generally does pick up, then it could expose unexpected frailties in financial markets..