A Study of Low Volatility Portfolio Construction Methods

Posted: 25 Jul 2013 Last revised: 28 Dec 2016

Tzee-man Chow

Research Affiliates, LLC

Jason C. Hsu

Rayliant Global Advisors; Research Affiliates, LLC; University of California, Los Angeles - Anderson School of Business

Li-Lan Kuo

Research Affiliates, LLC

Feifei Li

Research Affiliates, LLC

Date Written: December 20, 2013

Abstract

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 naïve 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.

Keywords: low volatility, smart beta, minimum variance

JEL Classification: G10

Suggested Citation

Chow, Tzee-man and Hsu, Jason C. and KUO, LI-LAN and Li, Feifei, A Study of Low Volatility Portfolio Construction Methods (December 20, 2013). Journal of Portfolio Management, Vol. 40, No. 4, 2014. Available at SSRN: https://ssrn.com/abstract=2298117 or http://dx.doi.org/10.2139/ssrn.2298117

Tzee-man Chow

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States
949-325-8754 (Phone)

Jason C. Hsu (Contact Author)

Rayliant Global Advisors ( email )

Hong Kong

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

HOME PAGE: http://www.jasonhsu.org

University of California, Los Angeles - Anderson School of Business

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

LI-LAN KUO

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

Feifei Li

Research Affiliates, LLC ( email )

620 Newport Center Dr
Ste 900
Newport Beach, CA 92660
United States
949-325-8753 (Phone)
949-325-8953 (Fax)

HOME PAGE: http://researchaffiliates.com/index.htm

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