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Low Volatility Needs Little Trading

Last Updated on 10 February, 2024 by Rejaul Karim

Navigating the intricate realm of low-volatility investing, Pim van Vliet unveils the art of subtlety in “Low Volatility Needs Little Trading.” In a fascinating exploration, he illuminates the efficiency of a low-volatility strategy, where minimal trading begets maximum results.

The empirical landscape unfolds, revealing a concave relationship between trading volume and risk reduction—a testament to the strategy’s nuanced efficacy. Simulated portfolios dance to a non-linear rhythm, showcasing diminishing marginal returns with each incremental turnover.

At a modest 30% trading level, a remarkable 25% reduction in portfolio volatility against the market index materializes. Van Vliet further dissects the liquidity and cost dynamics, emphasizing that low-volatility stocks, inherently more substantial, embody a cost-effective allure.

This revelation transcends low volatility, echoing the law of diminishing returns across alpha factors like value and momentum, culminating in a multi-faceted strategy with minimal trading costs and maximal factor exposure.

Abstract Of Paper

An efficient low-volatility strategy only needs a little amount of trading. The empirical literature on low-volatility investing reveals a concave relation between the amount of trading and the risk reduction. Portfolio simulations confirm this non-linear pattern in which each increase in turnover results in smaller marginal reductions in volatility. In general a moderate trading level of 30% is enough to reduce portfolio volatility by 25% compared with the market index. In addition, low-volatility stocks are relatively liquid and cheap to trade, primarily because they are much larger than the average stock. The law of diminishing returns also applies to other alpha factors such as value and momentum and integrating them into a multi-factor low-volatility strategy is an efficient way to increase factor exposure at low trading costs.

Original paper – Download PDF

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Author

Pim van Vliet
Robeco Quantitative Investments

Conclusion

In summary, an efficient low-volatility strategy demonstrates that less is indeed more when it comes to trading. Extensive empirical research illustrates a diminishing, concave relationship between the amount of trading and the achieved risk reduction. Portfolio simulations affirm this non-linear pattern, showcasing that incremental increases in turnover yield progressively smaller marginal reductions in volatility.

A modest trading level of around 30% emerges as sufficient to curtail portfolio volatility by 25% compared to the market index. Furthermore, the inherent characteristics of low-volatility stocks, characterized by ample liquidity and cost-effectiveness in trading, contribute to the strategy’s appeal.

This principle of diminishing returns holds not only for low-volatility strategies but also extends to other alpha factors like value and momentum. The integration of these factors into a multi-factor low-volatility approach emerges as an efficient strategy to enhance factor exposure without incurring exorbitant trading costs.

Related Reading:

The Profitability of Low Volatility

Are Hedge Funds on the Other Side of the Low-Volatility Trade?

FAQ

1. What is the main finding regarding the relationship between trading volume and risk reduction in low-volatility investing, as revealed by Pim van Vliet’s research?

The main finding is that there is a concave relationship between the amount of trading and the achieved risk reduction in low-volatility investing. The research demonstrates that as trading volume increases, the incremental reductions in portfolio volatility become progressively smaller. This non-linear pattern suggests that an efficient low-volatility strategy requires only a modest amount of trading to achieve significant risk reduction.

2. According to the paper, what is the significance of a 30% trading level in a low-volatility strategy, and how much reduction in portfolio volatility does it result in compared to the market index?

The paper suggests that a modest trading level of around 30% is sufficient to achieve a substantial reduction in portfolio volatility. Specifically, at this trading level, there is a remarkable 25% reduction in portfolio volatility compared to the market index. This finding emphasizes the efficiency of low-volatility strategies, as they can achieve significant risk reduction with relatively low levels of trading activity.

3. How does the research highlight the characteristics of low-volatility stocks in terms of liquidity and trading costs, and how does this contribute to the appeal of the low-volatility strategy?

The research emphasizes that low-volatility stocks are relatively liquid and cost-effective to trade. This is attributed to the inherent characteristics of low-volatility stocks, which tend to be larger than the average stock. The larger size of these stocks makes them more liquid and less costly to trade. This liquidity and cost-effectiveness contribute to the appeal of the low-volatility strategy, making it an efficient option for investors seeking to manage risk with minimal trading costs.

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