A Study of Low-Volatility Portfolio Construction Methods

In this study, the authors examine the hypothetical performance of various low volatility strategies in historical U.S., global developed, and emerging markets. The strategies we replicated outperformed cap-weighted market indices due to exposure to the value, BAB (betting against beta), and duration factors. (The duration factor introduced by the authors here is new to the literature.) A reduction in market beta drives the drop in volatility. The authors report that low volatility strategies can contribute to a more risk-diversified equity portfolio which earns long-term returns from multiple premium sources. The lower risk and higher return seem persistent across geographies and over time. Nonetheless, the authors identify flaws with naive approaches to portfolio construction, which tend to result in high turnover, low liquidity, and concentrated country and industry allocations. Additionally, price increases would eliminate low volatility stocks' performance advantage. The conclusion of the authors is that the portfolio construction methods should be sensitive to the investability and valuation levels.