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Low Risk Anomaly Everywhere – Evidence from Equity Sectors

Last Updated on 10 February, 2024 by Rejaul Karim

Embarking on a comprehensive exploration of market anomalies, Raul Leote de Carvalho and his collaborators unravel the intriguing “Low Risk Anomaly Everywhere – Evidence from Equity Sectors.” In this financial odyssey, the researchers illuminate a pervasive pattern across developed and emerging markets: stocks with the least risk in various industry sectors consistently outshine their riskier counterparts.

Their findings hint at a nuanced interplay between sector specialization among equity analysts and fund managers, influencing the risk-return dynamics. Unveiling the implications for sector-neutral strategies, the study unveils an efficiency that outpaces non-sector neutral approaches, offering insights into alpha generation, sector allocation, and the broader landscape of low-risk investing in global financial markets.

Abstract Of Paper

We give strong empirical evidence of a risk anomaly in equity sectors in a number of regions and countries of developed and emerging markets, with the lowest risk stocks in each activity sector generating higher returns than would be expected given their levels of risk, and the converse outcome for the riskier stocks. We believe this evidence is a likely consequence of the fact that equity analyst and active fund managers tend to specialize in particular sectors and to mainly select stocks from those sectors. Additionally, constraints restricting the deviation of sector weights in active portfolios against their market capitalization benchmarks are often used by active fund managers, in particular by quantitative managers which tend to go as far as being sector neutral. As a consequence, we find that sector-neutral, low-risk approaches appear more efficient at generating alpha than non-sector neutral approaches, with the latter showing strong sector allocation towards financials, utilities and consumer staples than sector neutral, at least when applied to developed countries in a global universe. We also discuss some properties of low-risk investing such as tail risk, turnover and liquidity.

Original paper – Download PDF

Here you can download the PDF and original paper of Low Risk Anomaly Everywhere – Evidence from Equity Sectors.

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Author

Raul Leote de Carvalho
BNP Paribas Asset Management

Majdouline Zakaria
BNP Paribas – BNP Paribas Investment Partners; Université Paris Dauphine – LEDa-SDFi

Lu Xiao
BNP Paribas Investment Partners

Pierre Moulin
BNP Paribas Investment Partners

Conclusion

In conclusion, the research underscores a robust low-risk anomaly prevalent across global equity sectors in both developed and emerging markets. This anomaly manifests as consistently higher-than-expected returns for low-risk stocks within each sector, challenging conventional risk-return assumptions.

Notably, sectors with specialized analyst and fund manager attention exhibit a more pronounced effect. The study advocates for sector-neutral, low-risk strategies as more efficient in generating alpha, disrupting traditional sector allocation practices.

Delving into nuances such as tail risk, turnover, and liquidity further illuminates the far-reaching impact of the low-risk anomaly in diverse global equity sectors.

Related Reading:

The Volatility Effect Revisited

Low-Volatility Cycles: The Influence of Valuation and Momentum on Low-Volatility Portfolios

FAQ

Q1: What does the research reveal about the low-risk anomaly in equity sectors?

A1: The research provides strong empirical evidence of a pervasive low-risk anomaly in equity sectors across various developed and emerging markets. Stocks with the least risk in each sector consistently generate higher-than-expected returns, challenging conventional risk-return assumptions.

Q2: How does sector specialization among analysts and fund managers influence the low-risk anomaly?

A2: The study suggests that sector specialization among equity analysts and fund managers plays a significant role in the low-risk anomaly. The tendency of experts to focus on specific sectors contributes to the observed pattern, influencing the risk-return dynamics within those sectors.

Q3: What is the recommendation for investors based on the research findings?

A3: The research advocates for sector-neutral, low-risk strategies as more efficient in generating alpha compared to non-sector neutral approaches. This challenges traditional sector allocation practices and provides insights for investors looking to capitalize on the low-risk anomaly in global equity sectors.

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