Low volatility doesn’t necessarily mean low growth | Fin24
 
Loading...

Low volatility doesn’t necessarily mean low growth

Nov 26 2019 14:39
Schalk Louw

Schalk Louw is a portfolio manager at PSG Wealth. (Picture: Supplied)

Related Articles

Are you comfortable swimming against the tide?

Measuring the value of a company

Mid-cap stocks to consider

 

I like to use well-known sayings to describe terms or market movements. 

But there is one saying that regularly makes its appearance in the investment world: “High risk, high reward.” 

Without wanting to offend thrill seekers, I want to make it clear right off the bat that I don’t associate myself with this saying. 

In fact, I disregard it completely. 

There are a few instances in which this saying can be proved wrong. 

One such area is when you interrogate different investment styles. 

We’re familiar with the three most popular styles, namely quality shares, momentum shares and value shares. 

For those who are not so familiar with these styles, here’s a quick overview

- Quality shares are valued based on strong returns on equity (ROE) and the lowest possible ratio of enterprise value to free cashflow. 

- Momentum investing, on the other hand, focuses only on share prices that rise sharply, while avoiding or selling shares that decline in value. 

- Value investing is more focused on shares that have higher earnings yields, lower price-to-book ratios and a lower ratio of enterprise-value-to-earnings before interest, taxes, depreciation, amortisation.

- There is another style or factor, however, that can be added to this list, called low volatility shares. 

This type of investing focuses on shares with the lowest possible volatility relative to their peers. 

Let’s have a look at one of the most well-known examples of low or minimum volatility benchmarks, the MSCI All Country World Minimum Volatility Index (ACWV).

This gauge aims to track the investment results of an index that consists of both developed and emerging market shares that collectively have lower volatility characteristics compared with the broader spectrum of developed and emerging equity markets. 

When we compare this index to the MSCI All Country World Index (ACWI), it is interesting to note that the ACWI has a three-year volatility ratio of 11.3%, while the ACWV has a volatility ratio of only 7.6% over the same period. 

The volatility ratio can be used quite effectively to determine the risk of a specific investment. 

When an investment in something like the ACWI has a volatility ratio of 11.3%, it means that this investment had already moved up and down by 11.3% over that three-year period. 

It also means that the ACWV traded at roughly two thirds of the ACWI’s risk (7.6% vs. 11.3%).

Let’s apply this to the saying about high risk and reward mentioned above. 

If this saying was true, surely you would have expected a much higher “reward”, seeing that you took more than one and a half times the risk? 

But the answer is no. 

The ACWV, however, delivered a return of 10.09% over the same period, and outperformed the ACWI by even more over a five-year period. 

Graph 1: MSCI World Factor Index ETFs

Schalk

Source: Thomson Reuters and PSG Old Oak


Looking at the local sectors, you will see that the picture still looks pretty much the same. 

By applying the same method to local style-orientated ETFs, you will see that no different to the international trend, momentum has also been the dominant factor for the last year and a half. 

Graph 2: South African Factor Index ETFs and Satrix40 

Schalk 2 

Source: Thomson Reuters and PSG Old Oak 

What you will see in graph 2, is that low volatility shares weren’t only the second-best performing factor locally, but they also outperformed the FTSE/JSE Top 40 Index ETF. 

As a final note, I want to make it clear that historical price movements do not guarantee any future performances. 

It is important to remember, though, that high risk does not necessarily mean high reward, so if you think that the markets may become temperamental going forward, low volatility shares can be considered as an investment alternative. 

investment  |  quality shares  |  benchmark
NEXT ON FIN24X

 
 
 
 
12 December issue
Subscribe to finweek
Loading...