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Equities White Paper

The Paradox of Low-Risk Stocks

Gaining More by Losing Less

June 05, 2015
4 min read

What You Need to Know

Contrary to conventional wisdom, research shows that less volatile stocks tend to beat the market over the long term, by losing less in downturns. Our own research found that an active approach combining low volatility and high fundamental quality produced even stronger performance. This strategy can be used as a source of uncorrelated alpha or as part of a plan’s overall risk management.

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12%
Relative performance of low-volatility stocks
during the Global Financial Crisis (2008-2009)
15%
Relative performance of low-volatility stocks
during the European debt crisis (2010-2011)
0.4%
Overlap of low-volatility stocks with value and growth stocks
In hypothetical global portfolio
Authors
Kent Hargis, PhD| Chief Investment Officer—Strategic Core Equities; Portfolio Manager—Global Low Carbon Strategy
Christopher W. Marx| Global Head—Equity Business Development

Wanted: A Better Shock-Resistant Equity Strategy

After the serial market jolts of the past decade, investors prize stability as never before. The pressure on plans to reduce funding volatility has only intensified with the passage of new pension-accounting and insurance-solvency regulations. For many investors, this poses a dilemma: they want (and need) equity-like returns, but not the performance swings and downside risk that come with equities. The search for a better shock-resistant equity strategy has sparked interest in a powerful yet long-unappreciated market anomaly—that less volatile stocks tend to outperform market indices over the long term.

Less volatile stocks are inherently less exposed to market booms and busts. They won’t soar as high in bull markets, but they generally won’t fall as much in crashes and, thus, have less to make back when the market recovers. As a result, these “Steady Eddies” typically compound more of their gains over a full market cycle.

The historical outperformance of low-risk stocks defies a central tenet of finance theory, which states that risk and return go hand in hand: accept more volatility and you’ll be paid with higher rewards over time. Yet, academic research confirms that the low-volatility anomaly has been observable for much of the past century. It also spans asset classes and geographies.

We did our own research into this anomaly’s investment potential and found that explicitly targeting both low volatility and measures of fundamental stability, and vetting for nearterm downside risks, produced even stronger results than passive low-volatility approaches.

A Robust But Different Kind of Anomaly

The low-volatility effect is as robust as more prominent anomalies found in low-valuation, small-capitalization and high price momentum stocks. Since 1973, the least volatile quintile of global stocks delivered returns that were one-third higher than the market, with 20% less volatility. This performance generated a more than 50% higher Sharpe ratio—or absolute return relative to risk.

But the low-volatility anomaly works very differently from its better-known counterparts. That's because it’s a "risk" anomaly, rather than a "return" anomaly. As such, it commands a distinct position on the efficient frontier, as illustrated in the display below, which shows the intersection of long-term average returns and volatility for hypothetical low-volatility, value, small-cap and high price momentum portfolios.

Even-Tempered Stocks Have More to Give

Results represent top quintiles within the MSCI World Index as sorted by low-yer training volatility, high price momentum, low price/book value and low capitalization, from January1973–March 31, 2015. Sharpe ration includes cash: capitalization-weighted MSCI World Index, gross, in USD unhedged.
Source: MSCI and AB

A long-only value, small-cap or price-momentum strategy seeks to deliver above-market returns at similar or incrementally higher levels of risk. In contrast, a low-volatility portfolio, like the physician vowing to "first, do no harm," aims to deliver market-like or better returns at below-market risk. Its strong suit is its protective behavior in crisis markets (Display below). The least volatile quintile of global stocks fared better than the market in seven of the past eight major downturns, including during the recent European debt crisis, when it outperformed the market by 15%.

Housing and Stocks Still Attractive Relative to Bonds

Past performance does not guarantee future results.
As of March 31, 2017
House P/E: National Association of Realtors Median Sales Price of Existing Single-Family Homes divided by median rent
Source: Strategas Research Partners and AB

Past performance, historical and current analyses, and expectations do not guarantee future results. There can be no assurance that any investment objectives will be achieved. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates.

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.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI.

About the Authors

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

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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