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

Last Updated on 10 February, 2024 by Rejaul Karim

In the intricate realm of equity investing, the phenomenon of low-volatility cycles takes center stage in “Low-Volatility Cycles: The Influence of Valuation and Momentum on Low-Volatility Portfolios” by Luis García-Feijóo, Lawrence Edward Kochard, Rodney N Sullivan, and Peng Wang.

This insightful research, set to grace the pages of the Financial Analysts Journal, delves into the burgeoning landscape of low-risk equity strategies. Unveiling the time-varying dynamics of these strategies, the study scrutinizes their performance, revealing a nuanced interplay with well-established factors like value, size, and momentum.

As the research unfolds, it unveils the intricate dance of low-risk portfolios with economic conditions, shedding light on the dynamic nature of their historical success and offering a fresh perspective on the ever-evolving landscape of quantitative investment strategies.

Abstract Of Paper

Research showing that the lowest risk stocks tend to outperform the highest risk stocks over time has led to rapid growth in so-called low-risk equity investing in recent years. We examine the performance of the low-risk strategy previously considered in the literature and of a beta-neutral low-risk strategy more relevant to practice. We demonstrate that the historical performance of low risk investing, like any quantitative investment strategy, is time-varying. We find that both of our low-risk strategies exhibit dynamic exposure to the well-known value, size, and momentum factors and appear to be influenced by the overall economic environment. Our results suggest time-variation in the performance of low-risk strategies is likely influenced by the approach to constructing the low-risk portfolio strategy and by the market environment and associated valuation premia.

Original paper – Download PDF

Here you can download the PDF and original paper of Low-Volatility Cycles: The Influence of Valuation and Momentum on Low-Volatility Portfolios.

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Author

Luis García-Feijóo
Florida Atlantic University – Department of Finance

Lawrence Edward Kochard
University of Virginia (UVA), Investment Management Company

Rodney N Sullivan
University of Virginia, Darden Graduate School of Business

Peng Wang
TIAA Institute – Covariance Capital Management

Conclusion

In conclusion, the study delves into the dynamic nature of low-volatility strategies, shedding light on their performance nuances over time. The established wisdom of low-risk stocks outperforming higher-risk counterparts is nuanced by the research, revealing a time-varying aspect in the efficacy of low-risk investing.

The exploration extends beyond the theoretical to practical relevance, considering a beta-neutral low-risk strategy. Notably, the performance of low-risk strategies is intricately linked to the broader economic environment, with dynamic exposure to factors such as value, size, and momentum.

This dynamicity prompts a reconsideration of the construction of low-risk portfolios and acknowledges the influence of market conditions and associated valuation premia on the effectiveness of such strategies. The findings underscore the need for a nuanced and adaptive approach to low-risk equity investing in response to evolving market dynamics.

Related Reading:

The Long and Short of the Vol Anomaly

Trend Momentum II: Driving Forces of Low Volatility and Momentum

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