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Are Low-Volatility Stocks the Answer to Market Swings?

October 10, 2018

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1 year 11 months
Submitted by Anonymous (not verified) on Wed, 10/10/2018 - 17:35

Investors caught off guard by the sudden return of market volatility in early 2018 may have found themselves newly appreciative of the steadier holdings in their stock portfolios. But low-volatility stocks aren’t just useful during bouts of turbulence—over time they actually tend to outperform their more-volatile peers.1

Of course, we’ve all been taught that with greater risk comes potentially greater rewards—and that wisdom holds true when comparing asset classes. (Equities, for example, tend to outperform lower-volatility bonds over the long term.) Within the category of equities alone, however, stocks with higher risk profiles may yield lower long-term returns.

A hypothetical portfolio comprising the Russell 1000® Index’s least-volatile stocks, for example, would have declined 27% during the depths of the 2008 financial crisis—compared with 37% for the Russell 1000 as a whole and 45% for the Russell 1000’s most-volatile stocks.2 And over the ensuing decade, that low-volatility portfolio would have continued to outperform—returning more than twice as much as its high-volatility counterpart (see “Built to last,” below).

So, what’s the best way to put low-volatility stocks to work in your portfolio? First you need to determine the volatility of the stocks you already own—say, by checking their Price Volatility Outlook in their Schwab Equity Ratings® reports (see “Storm watch,” below). Once you know your exposure, you can determine whether it makes sense to shift additional dollars into less-volatile equities.

Storm watch

Schwab Equity Ratings, which assigns letter grades A through F to approximately 3,000 U.S.-traded stocks, now includes a Price Volatility Outlook as a way to gauge expected volatility during the next six months. To view a stock’s Price Volatility Outlook, log in, enter its ticker symbol in the search field, click its Schwab Equity Rating grade and then click on the Schwab Equity Ratings Report link on the right-hand side to view an in-depth PDF.

How much, if any, to shift depends on your tolerance for big price swings. Aggressive investors may wish to keep low-volatility stocks to a minimum, whereas more conservative investors might choose to migrate a greater portion of their portfolios into relatively stable stocks.

That said, there might be times when a historically turbulent share price is worth the risk. Investors in technology stocks, for instance, are often willing to stomach their ups and downs in exchange for potentially higher growth.

In the end, what matters most is building a portfolio you can live with, even as markets go through their inevitable gyrations. Knowing all you can about your individual holdings should help you help you do just that.

Steven Greiner, Ph.D., is a senior vice president of Schwab Equity Ratings at the Schwab Center for Financial Research.

Mahmoud Shammaa, CFA, is a director of Schwab Equity Ratings at the Schwab Center for Financial Research.

1Andrew Ang, Robert J. Hodrick, Yuhang Xing and Xiaoyan Zhang, “The Cross-Section of Volatility and Expected Returns,” The Journal of Finance, February 2006. Xi Li, Rodney N. Sullivan and Luis Garcia-Feijóo, “The Low-Volatility Anomaly: Market Evidence on Systematic Risk vs. Mispricing,” Financial Analysts Journal, Vol. 72, No. 1, 2016.

2Every month over a 20-year period, all Russell 1000 companies were ranked by their past one-year volatility, with the lowest-volatility tercile classified as low volatility and the highest-volatility tercile classified as high volatility.