Low-volatility investing is a strategy that focuses on stocks with historically lower price fluctuations, aiming to achieve strong risk-adjusted returns. Despite conventional finance theory suggesting that higher risk should lead to higher returns, research has shown that low-volatility stocks often outperform their high-volatility counterparts on a risk-adjusted basis. By reducing drawdowns and offering a smoother return profile, low-volatility investing appeals to risk-conscious investors, particularly in uncertain market environments.
Given the appeal of low-volatility investing, there are, however, some concerns about its sensitivity to changes in interest rates, particularly its viability in a higher-yield environment. Reference [1] investigates this issue. The authors pointed out,
The results confirm that low-volatility stock deciles do indeed exhibit positive, statistically significant bond betas (that become negative for high-volatility deciles), and this exposure carries over to the most popular low-volatility indexes such as the S&P 500 Low Volatility Index and the MSCI USA Minimum Volatility Index, even after accounting for their exposures to value, quality, and investment factors. The estimated bond betas roughly correspond to a duration of a two-year Treasury bond, but—as our robustness tests show—this sensitivity does not appear to be very stable over time. It can be quite effectively mitigated by applying leverage (especially within the context of long–short strategies) or by carefully avoiding excessive industry tilts, such as overallocating to companies from the utilities or consumer staples sector.
… Even in 2022, one of the worst years on record for US Treasuries, exposure to interest rates failed to materially affect the performance of low-volatility strategies. The negative bond contribution was more than offset by high positive returns on undervalued, high-quality, and conservative stocks overrepresented in low-volatility portfolios. On a more pessimistic note, however, equity style exposures of our sample low-volatility strategies seem to account for much of their raw excess returns generated in the past 30 years, suggesting some skepticism as to how much value added these strategies can bring to an already diversified and quality-tilted portfolio.
In short, the results confirm that long-only low-volatility strategies exhibit positive, statistically significant bond betas, even after controlling for exposures to value, quality, and investment factors. However, this sensitivity is not stable over time and can be effectively mitigated through leverage or by avoiding excessive industry concentrations.
This article sheds new light and provides insights into low-volatility investing. Let us know what you think in the comments below or in the discussion forum.
References
[1] Juliusz Jabłecki, Low-Volatility Equity Strategies and Interest Rates: A Bittersweet Perspective, The Journal of Beta Investment Strategies, Volume 16, Issue 1 Spring 2025
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