Home Trading strategies Low Volatility Stocks Strategy – Beta, Performance, Investing, Factor, Returns

Low Volatility Stocks Strategy – Beta, Performance, Investing, Factor, Returns

Some stocks, and indeed some stock market sectors, are known for their relatively stable prices and little intraday fluctuations. Some traders and investors prefer such stocks, as they make use of low volatility stocks strategy. Want to know more about the low volatility stock strategy?

Low volatility stock strategy involves investing in stocks with lower volatility or price fluctuation than the overall market. These stocks may provide more consistent returns and less risk, and in they have also proven to offer a better return than high volatility returns (in the long run). In the short run, however, they might be better which is why they may not appeal to day traders and swing traders.

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In this post, we look at low volatility stocks strategy, and we end the article with a backtest of this factor investing strategy.

Related reading: Searching for an investment strategy? (We have hundreds)

Introduction to Low Volatility Stocks (Low Beta)

Low volatility stocks have relatively stable prices and experience less price fluctuation than the overall market. These stocks are often considered less risky investments, as they are less likely to experience significant declines in value. However, they may also provide lower returns compared to higher volatility stocks, depending on the time horizon.

Low volatility stocks can come from various sectors and industries, such as consumer staples, utilities, and healthcare. By definition, low volatility stocks are stocks that have a low beta — the measure of a stock’s volatility relative to the overall market. A beta of less than 1 indicates that a stock is less volatile than the market, while a beta greater than 1 indicates more volatile.

We have previously both covered utility and consumer staples. They are excellent for trading:

Low volatility stocks are often seen as a safer option for investors who are looking to reduce risk and achieve more consistent returns. This can be especially appealing for investors who are nearing retirement or have lower risk tolerance.

One strategy for investing in low volatility stocks is to focus on companies with stable earnings and consistent dividends. These companies have a track record of steady financial performance and a lower likelihood of experiencing large price fluctuations. Additionally, these companies may have a more predictable business model and lower debt, making them less risky investments.

Understanding the Low Volatility Strategy

The low volatility strategy is an investment approach focusing on stocks or market segments with relatively stable prices and less price fluctuation than the overall market. These stocks are often considered to be less risky investments, as they are less likely to experience large declines in value.

One of the key principles of the low volatility strategy is that it aims to minimize portfolio volatility while still achieving returns. This is achieved by investing in stocks with lower volatility or price fluctuation than the overall market. By doing this, an investor can reduce the risk of large declines in their portfolio’s value.

To implement a low volatility strategy, you have to look for companies with stable earnings and consistent dividends, as such companies tend to have a track record of steady financial performance and have a lower likelihood of experiencing large price fluctuations.

Moreover, those companies may have a more predictable business model and lower debt, making them less risky investments. Another way is to look for companies that have a low beta, which measures a stock’s volatility relative to the overall market. Low volatility stocks would have a beta of less than 1 — that is, they are less volatile than the market.

In recent years, low volatility strategies have gained popularity as a way to manage risk and achieve more consistent returns. Many investors and fund managers now use low volatility strategies to manage risk and achieve more consistent returns. However, it is important to understand that like any investment strategy, low volatility also has its own set of risks and limitations, and it may not suit your goals and risk tolerance. These stocks also suffer long periods of underperformance (like any other factor investing strategy).

Also, it’s important to note that while low volatility stocks may provide more consistent returns, they may also come with lower returns compared to higher-volatility stocks. However, empirical research over many decades has shown that low volatility stocks have outperformed high volatility stocks, which is not consistent with financial theory!

But past performance does not guarantee future results. So, you have to conduct thorough research before making any investment decisions.

Benefits of Low Volatility Investing

Let’s look at some of the benefits of low volatility investing:

  • Reduced risk: Low volatility stocks experience less price fluctuation, so they are less likely to experience large declines in value. This is important because history shows we make more behavioral mistakes the more volatile an asset is.
  • Consistent returns: Low volatility stocks are known to provide more consistent returns compared to high-volatility stocks. This is because they are less likely to experience large declines in value, which can help to smooth out returns over time. Again, investors tend to favor consistent returns over “random” results, even though the end result is the same.
  • Focus on fundamentals: Investing in low volatility stocks often requires you to focus on fundamentals, such as earnings and dividends, which can help you to identify strong companies in good financial health. Low volatility stocks tend to have more predictable business models.
  • Diversification: Investing in low volatility stocks can help to diversify a portfolio and reduce overall portfolio risk. By including low volatility stocks, you can reduce the impact of market downturns on their portfolio.
  • Risk management: Low volatility strategies are often used as a way to manage risk and achieve more consistent returns. By investing in low volatility stocks, an investor can reduce the risk of large declines in their portfolio’s value.

Potential Risks of Low Volatility Stocks

Let’s switch to the potential risks with low volatility stocks. Some of them include the following:

  • Returns: History shows that low volatility stocks have produced better returns than high volatility stocks, but history might not repeat.
  • Overvaluation: Low volatility stocks may become overvalued due to investors paying a premium for the perceived safety of these stocks. This can lead to a higher risk of a price decline if the market changes or if the company’s fundamentals deteriorate.
  • Sector-specific risk: Low volatility stocks may be concentrated in a specific sector, such as utilities or consumer staples. This can lead to increased risk if that sector experiences a downturn.
  • Limited upside potential: Low volatility stocks may have limited upside potential, as they are less likely to experience large price movements. This can be especially concerning during market upturns, when higher volatility stocks may provide greater returns. It’s mostly in recessions that low volatility stocks perform better.
  • Diversification risk: Investing only in low volatility stocks may not always be the best approach to diversifying a portfolio, as these stocks may have similar characteristics or be correlated with each other. This can lead to increased risk if there is a market downturn.
  • Lack of flexibility: A low volatility investment strategy may limit an investor’s ability to take advantage of market opportunities or changes. It may also limit the ability to capitalize on market downturns, as low volatility stocks may decline as well.
  • Dependence on Market condition: The effectiveness of a low volatility strategy depends on the current market conditions, which can change over time.

How to Implement a Low Volatility Strategy

Implementing a low volatility strategy can be done in a few different ways:

  • Invest in low volatility ETFs or mutual funds: Exchange-traded funds (ETFs) and mutual funds that track low volatility stocks can be an easy way to implement a low volatility strategy. These funds are diversified and can provide exposure to a variety of low volatility stocks. The ETF with the ticker code SPLV might be an option.
  • Identify low volatility stocks: It is possible to identify low volatility stocks by analyzing historical price data and measuring volatility over a given period. Investors can use this information to select stocks with lower volatility than the overall market. When identified, they can use a combination of technical and fundamental analysis to select the right stocks to invest in.
  • Diversify your portfolio: It is important to diversify your portfolio when implementing a low volatility strategy. This can be done by investing in a variety of low volatility stocks across different sectors, which can help to reduce risk.
  • Consider the market conditions: Before implementing a low volatility strategy, it is important to consider the current market conditions. In a bear market, low volatility stocks may provide better protection than high volatility stocks.
  • Regularly review and adjust your portfolio: Regularly reviewing and adjusting your portfolio is crucial in order to ensure that your investments align with your risk tolerance and financial goals.

Building a Low Volatility Portfolio

Building a low volatility portfolio involves selecting stocks or other securities with lower volatility than the overall market.

Please keep in mind that you need a long time horizon to make the low volatility strategy pan out. We are talking about years – perhaps even decades.

The easiest way to achieve a low volatility portfolio is to invest in low volatility ETFs or mutual funds that track low volatility stocks. These funds are diversified, can provide exposure to a variety of low volatility stocks, and are portfolios on their own. Earlier in the article we mentioned the ETF with the ticker code SPLV. This is an ETF that invests solely in low volatility stocks.

However, if you want to build a portfolio of low volatility stocks by yourself, you can identify low volatility stocks by analyzing historical price data and measuring volatility over a given period. Then, you can use a combination of technical and fundamental analysis to choose the right low volatility stocks for your portfolio (or whatever method you prefer). Diversify your portfolio by investing in a variety of low volatility stocks across different sectors, which can help to reduce risk.

It is important to regularly review and adjust your portfolio to ensure that your investments align with your risk tolerance and financial goals. Such a portfolio would probably need some adjustments or rebalancing annually or less.

Backtesting the Low Volatility Strategy

Backtesting a low volatility strategy involves analyzing historical market data to evaluate how well the strategy would have performed in the past. If you are not sure what a backtest is, please read articles in our library. This can be done in a few different ways:

  • Use a stock screener to select the stocks to backtest: Stock screeners can be used to filter through a large number of stocks and identify those that meet specific criteria, such as low volatility. This can help to identify potential low volatility stocks that could be included in a portfolio.
  • Gather historical data: Analyzing price data and measuring volatility over a given period can help identify low volatility stocks that have performed well in the past. But you need to source the data, as your backtesting platform may not offer historical data for a long period. One of the sources of such data is Yahoo Finance.
  • Use a backtesting platform to implement the test: You use a backtesting platform to simulate trades using the historical market data you gathered. This way, you can see how the strategy would have performed in the past if you had used it.
  • Optimize the strategy: You can tweak the parameters of the strategy and backtest again using out-of-sample data. This can be used to optimize a portfolio’s risk-return trade-off. It can also help to identify the optimal mix of low volatility stocks that maximizes returns while minimizing risk. For example, put stocks in deciles and rank deciles based on performance.
  • Compare the strategy to a benchmark: Compare the performance of the low volatility strategy to a benchmark index, such as the S&P 500, to evaluate how well the strategy has performed relative to the market.

It’s important to note that backtesting a strategy can only provide a rough estimate of its performance, and it may not always accurately predict future results.

Strategies to Enhance Low Volatility Returns

Can you enhance the return of a low volatility portfolio?

Yes, there are several strategies that can be used to enhance returns from low volatility stocks:

  • The use of leverage: Leverage can be used to increase returns by borrowing money from the broker to invest in low volatility stocks. However, leverage also increases risk, so it should be used with caution. That said, it’s better to use leverage on such a group of stocks than high volatility stocks.
  • Investing in dividend-paying low volatility stocks: Dividend-paying low volatility stocks can provide a steady stream of income in addition to the potential for capital appreciation. Dividends can help to reduce the overall volatility of a portfolio. However, a dividend is not really income – it’s a distribution of shareholder’s equity.
  • Using options to generate additional income: Options can be used to generate additional income by selling call options against low volatility stocks. This strategy, known as covered call writing, can help generate income while also reducing volatility.
  • Using a value strategy: This strategy involves investing in undervalued stocks that are trading at a discount to their intrinsic value. It can be used to identify and invest in undervalued low volatility stocks that have the potential for growth.
  • Using a momentum strategy: This strategy involves investing in stocks that have been trending upward. It can be used to invest in low volatility stocks that have been performing well in the recent past and are likely to continue to do so.
  • Using a combination of strategies: A combination of strategies can be used to enhance returns from low volatility stocks. For example, a combination of value and momentum strategies can be used to identify undervalued stocks that have been performing well.

It’s important to note that while these strategies can help enhance returns, they also come with their own set of risks.

Rebalancing a Low Volatility Portfolio

Rebalancing a low volatility portfolio involves adjusting the weightings of the different stocks in the portfolio to ensure that they align with the desired level of risk and return.

Here are a few key steps for rebalancing a low volatility portfolio:

  • Establish target allocations: Determine the desired weightings for each stock in the portfolio based on their risk and return characteristics. For example, a low volatility investment portfolio may have a higher weighting in bonds and a lower weighting in equities.
  • Monitor portfolio performance: Monitor the performance of the portfolio on a regular basis to know when to adjust or rebalance the portfolio to align with the target allocations.
  • Sell overperforming assets and buy underperforming ones: If any asset has grown so much that its weighting has gone significantly above the target allocation, sell some of it and buy the underperforming asset to bring the portfolio back in line with the target allocation.
  • Review the portfolio for any changes in risk tolerance, financial goals, or market conditions: It’s important to regularly review the portfolio and make adjustments as necessary, based on any changes in risk tolerance, financial goals, or market conditions. This should be done regularly, say quarterly, semi-annually, or annually.
  • Consider the tax implications: Rebalancing a portfolio can generate capital gains or losses, which can have tax implications, especially for individuals. It’s important to consider these tax implications when rebalancing a low volatility portfolio.

Conclusion: Is Low Volatility Investing Right for You?

Low volatility investing is a strategy focusing on stocks or assets with lower volatility and exhibit a less dramatic fluctuation in price. This approach can offer a more steady return on investment and can be less risky than investing in more volatile stocks.

However, it’s not suitable for everyone. Here are a few things to consider when determining if low volatility investing is right for you:

  • Your risk tolerance: If you are a more conservative investor with a low risk tolerance, low volatility investing may be a good fit for you. However, if you are a more aggressive investor who is comfortable with higher risk, low volatility investing may not be the best fit. You need to know your pain thresholds. Experience indicates most investors can’t tolerate as big drawdowns as they believe.
  • Your investment horizon: Low volatility investing is typically better suited for long-term investors with a time horizon of five years or more (even decades).
  • Your financial goals: If your primary goal is to preserve capital and generate steady returns, low volatility investing may be a good fit. However, if your primary goal is to achieve high returns quickly, low volatility investing may not be the best fit. But most investors that want to get rich quickly end up penniless. The risk is real!
  • Your current portfolio: If you currently have a high-risk portfolio and are looking to reduce your exposure to volatility, low volatility investing may be a good fit.

Low Volatility Stocks Strategy Backtest – Returns, performance, and volatility

Let’s first look at the volatility of low and high volatility stocks. We use rolling returns of two ETFs: SPLV as a proxy for low volatility stocks and SPHB for high volatility stocks. Both ETFs started trading in 2011:

Low Volatility Stocks Strategy performance and returns
6 months rolling returns SPLV vs. SPHB.

Clearly, the pink line, which shows the rolling returns for high volatility stocks (SPHB), has a much higher volatility than the blue line (SPLV).

Low volatility stocks performance and returns

Plenty of academic research has concluded that low volatility stocks outperform the most volatile ones.

Professor Kenneth French reviewed the data from 1964 to 2015 and looked at the performance of high volatility stocks. An interesting finding from the survey is the poor returns from the 10% most volatile stocks:


S&P 50010% most volatile stocks
Years when S&P 500 goes up17,78%17,1%
Years when S&P 500 goes down-13,95%-35,35%

The statistics show that the most volatile stocks hold up when the market goes up (in theory, they should rise more), but when the market falls, they perform poorly.

The three worst years for the S&P 500 during this period were 1974, 2002, and 2008 when the S&P 500 fell 26%, 22%, and 36.6%, respectively. The statistics for the volatile stocks were 44.4%, 52.3 and 60.3%.

Long-term data indicates it’s best to avoid the 10% most volatile. Rolling 10-year returns show that high volatility has consistently produced lower returns than low volatility.

Another significant result from French’s research is that the three lowest deciles (divided into groups of 10%) with the lowest volatility have never shown a negative return during any ten-year-period since 1974.

Let’s look at the relationship between market value and volatility for US stocks from 1963 to 2018 (research done by “Plotous” on SeekingAlpha):


Lowest volatilitySecond lowestMedian volatilitySecond highestHighest volatility
Lowest market cap16.73%17.54%15.58%10.48%-2.76%
Second lowest15.20%16.1%15.64%12.99%3.43%
Median market cap13.43%13.71%14.84%13.18%5.76%
Second highest12.69%13.0%12.96%12.02%6.9%
Highest market cap9.72%10.87%10.15%8.95%7.81%

The table shows that the stocks with the lowest market value and the highest price variation/volatility have produced negative returns since JF Kennedy was president!

Omitting this group of stocks can help to improve returns. The research shows that it is best to search among boring stocks with low market value (small-cap).

Warren Buffett and Berkshire Hathaway and the low volatility factor

Warren Buffett and his Berkshire Hathaway confirm the low volatility hypothesis. Andrea Frazzini, David Kabiller, and Lasse Pedersen have, in an article called Buffett’s Alpha, published in the Financial Analysts Journal in 2013, gone through Berkshire’s listed share portfolio.

They found that Berkshire had the highest Sharpe Ratio of all stocks listed in the US between 1926 and 2011 of those stocks listed for at least 30 years!

Likewise, Berkshire had a higher Sharpe Ratio than all mutual funds that have existed for more than 30 years. However, the Sharpe ratio between 1976 and 2011 is still only 0.76, probably much less than many imagined (but it is still twice as high as the market).

Here are the conclusions from the research:

Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks . Decomposing Berkshires’ Portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management….. Interestingly, stocks with these characteristics – low risk, cheap , and high quality – tend to perform well in general, not just the ones that Buffett buys….. Finally, he managed to stick to his principles and continue operating at high risk even after experiencing some ups and downs that have caused many other investors to rethink and retreat from their original strategies.

The low volatility effect/factor – international markets

Yes, research confirms that the low volatility anomaly/factor exists in most international stock markets.

Nardin Baker and Robert Haugen issued a note in April 2012 called Low Risk Stocks Outperform within All Observable Markets in the World.

The authors examined the low-volatility hypothesis among 21 exchanges in developed economies, as well as 12 exchanges in emerging markets. This figure indicates that the anomaly exists everywhere:

Low Volatility Stocks Strategy backtest

“Return difference” is the difference in annual return between the high and low volatility groups. Furthermore, “Sharpe ratio” shows that the risk-adjusted return is much better for shares with low volatility.

This chart shows the relationship better:

Low volatility stocks - risk and performance

We end the article with a plot showing the rolling 3-year difference in return:

Low vs high volatility return differentials

Low volatility stocks strategy – conclusion

Why do low-beta stocks outperform?

Malcolm Baker, Brendan Bradley, and Ryan Taliaferro wrote in the September 2013 a research note called The Low Beta Anomaly: A Decomposition into Micro and Macro Effects about three possible explanatory variables:

  1. Investors are irrational and gravitate towards “lotteries”. We are attracted to big wins even if the probability of winning is small.
  2. We overestimate the ability to find amazing stocks like Amazon, Apple, and Google. This entails investing in high-beta stocks in the hope of hitting the right stock.
  3. Most investors overestimate their ability to pick winners.

Another factor is that stocks with high volatility have an uncertain business model. When this is the case, it is often difficult to determine the correct valuation. New information and news, therefore, substantially impact the share price.

Within the high volatility group, we also find newly established companies that may present a new idea or perhaps a break with existing businesses. It is challenging to pick the very few stocks that go on to become multibaggers. Therefore, perhaps the best option is to invest defensively in “boring” stocks.

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