Are Low-Volatility Stocks Too Expensive?

17 January 2020

3 min read

Kent Hargis, PhD| Chief Investment Officer—Strategic Core Equities; Portfolio Manager—Global Low Carbon Strategy

Sammy Suzuki, CFA| Head—Emerging Markets Equities

Christopher W. Marx| Global Head—Equity Business Development

Even as global stocks climbed in 2019, market volatility persisted. By some measures, lower-volatility stocks now look quite expensive. But in fact, high-quality stocks that can help protect portfolios can be found at reasonable prices, if you know where to look.

Equity investors had a wild ride in 2019. The MSCI World Index surged by 27% in 2019 in local-currency terms, defying headlines about US-China trade tensions, global political risk and macroeconomic concerns. The gains, however, have been anything but steady. Over the past two years, the market rose or fell by more than 1% on 71 days—a huge increase from 2017, when such sharp gains or losses happened only five times.

Strong Demand for Smoother Return Patterns

Sticking with equities sometimes requires nerves of steel. And not everyone can handle the pressure. That’s why many investors have turned to lower-volatility stocks, which aim to capture equity return potential with smoother trading patterns. Exchange-traded funds with “low volatility” or “minimum volatility” in their names had assets of US$106.8 billion as of December 31, driven by strong inflows of US$28.2 billion through the year, according to Morningstar data.

Their popularity has created a challenge—low-volatility stocks look expensive. By the end of December, the MSCI World Minimum Volatility (Min Vol) Index traded at a price/earnings ratio of 23.9, a 20% premium to the MSCI World (Display, left). In historical terms, the Min Vol is toward the top of its valuation range versus the MSCI World since 2003 (Display, right). For many, that looks like a high price to pay for stability.

Valuations of Lower-Volatility Stocks Look Relatively High

Historical and current analyses do not guarantee future results.
As of December 31, 2019
Source: FactSet, MSCI and AllianceBernstein (AB)

But benchmarks can be misleading. Since they focus on a narrowly defined set of lower-volatility characteristics and do not consider valuation, indices can be easily skewed toward more expensive stocks and sectors.

Buying Quality at the Right Price

What’s more, some of these sectors don’t offer the quality you might expect in a lower-volatility allocation. For example, profitability in the utilities, telecom and consumer-staples sectors is very low compared to their history since 2003 (Display). Yet the Min Vol has a large overweight in each of these sectors versus the broader MSCI World. Meanwhile, the profitability of technology stocks is very high in historical perspective, yet the Min Vol is underweight the sector.

Look for Quality Across Sectors to Find Good Value

Historical and current analyses do not guarantee future results.
As of December 31, 2019
Source: FactSet, MSCI and AllianceBernstein (AB)

In a global allocation, regional differences matter too. For example, our research shows that stocks offering quality and stability are relatively expensive in Europe today.

The moral of this story is that valuations can’t be viewed in a vacuum. Investors must scrutinize individual stocks to gauge whether they have quality cash flows to support stable return patterns. Sometimes it’s worth paying a bit more for especially high-quality businesses. And some expensive stocks that belong to a traditionally defensive sector don’t have the underlying quality to justify the price tag.

Low-Vol Portfolios Aren’t Created Equal

Low-volatility portfolios aren’t all the same. To be effective, we believe a low-volatility portfolio should target reasonably priced stocks of high-quality businesses that can produce robust cash flows through changing market environments.

Investors are right to be concerned about valuations. If stock markets correct after a strong year, expensive names may get hit.

But it’s not a good reason to shun stocks, in our view. Since it’s almost impossible to time market inflection points, a low-volatility equities allocation with a clear focus on attractive valuations can be an antidote to future volatility and allow investors to stay in the market and benefit from the stronger long-term return potential of equities.

Passive strategies aren’t sensitive to valuations when allocating to low-volatility stocks. Some relatively expensive sectors, such as utilities, are among the largest overweights in the Min Vol. And the index or passive portfolios can’t sift out or adjust weights of individual stocks with high valuations. By emphasizing attractive valuations in holdings, we believe active investors can create portfolios with stable return patterns that can withstand more pressure in stormy weather than their passive peers.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

About the Authors

Kent Hargis, PhD

Kent Hargis is the Chief Investment Officer of Strategic Core Equities. He created the Strategic Core platform and has been managing the Global, International and US Strategic Core portfolios since their inception in 2011. Hargis has also been Portfolio Manager for the Global Low Carbon Strategy Portfolio since 2022. Previously, he managed the Emerging Portfolio from 2015 through 2023. Hargis was global head of quantitative research for Equities from 2009 through 2014, with responsibility for directing research and the application of risk and return models across the firm’s equity portfolios. He joined AB in 2003 as a senior quantitative strategist. Prior to that, Hargis was chief portfolio strategist for global emerging markets at Goldman Sachs. From 1995 through 1998, he was assistant professor of international finance in the graduate program at the University of South Carolina, where he published extensively on various international investment topics. Hargis holds a PhD in economics from the University of Illinois, where his research focused on international finance, econometrics and emerging financial markets. Location: New York

Sammy Suzuki, CFA

Sammy Suzuki is Head of Emerging Markets Equities, responsible for overseeing AB’s emerging-markets equity business and instrumental in the formation and shaping of AB’s Emerging Markets Equity platform. He was also a key architect of the Strategic Core platform and has managed the Emerging Markets Portfolio since its inception in 2012, and the Global, International and US portfolios from 2015 to 2023. Suzuki has managed portfolios since 2004. From 2010 to 2012, he also held the role of director of Fundamental Value Research, where he managed 50 fundamental analysts globally. Prior to managing portfolios, Suzuki spent a decade as a research analyst. He joined AB in 1994 as a research associate, first covering the capital equipment industry, followed by the technology and global automotive industries. Before joining the firm, Suzuki was a consultant at Bain & Company. He holds both a BSE (magna cum laude) in materials engineering from the School of Engineering and Applied Science, and a BS (magna cum laude) in finance from the Wharton School at the University of Pennsylvania. Suzuki is a CFA charterholder and was previously a member of the Board of the CFA Society New York. He currently serves on the Board of the Association of Asian American Investment Managers. Location: New York

Christopher W. Marx

Christopher W. Marx is Senior Vice President and Global Head of Equity Business Development. He is responsible for overseeing the firm's team of equity investment strategists and product managers, setting strategic priorities and goals for the global Equities business, developing new products, and engaging with clients to represent market views and investment strategies of the firm. Previously, Marx was a senior investment strategist and a portfolio manager of Equities, and in 2011 he cofounded the Global, International and US Strategic Core Equity portfolios with Kent Hargis. He joined the firm in 1997 as a research analyst covering a variety of industries both domestically and internationally, including chemicals, metals, retail and consumer staples. Marx became part of the portfolio-management team in 2004. Prior to joining the firm, he spent six years as a consultant for Deloitte & Touche and Boston Consulting Group. Marx holds a BA in economics from Harvard University and an MBA from the Stanford Graduate School of Business. Location: New York

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