Things you should know about minimum volatility investing

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Things you should know about minimum volatility investing

Post by hdas » Sun Feb 17, 2019 11:37 am

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I've been looking into the Low Vol Anomaly for my individual stock portfolio project, I found this good precis from Robeco [1][2]:

1. The minimum volatility portfolio (MVP) exists only in theory. In practice, the MVP can only be determined historically (ex post) for a specific sample and return frequency. This means different low volatility portfolios (LVP) co-exist, all aiming to reduce and minimize future volatility (ex ante). In general, most LVPs have high average exposures to low volatile stocks2 and low beta stocks. As a result, the name of this new emerging investment style evolved over time from ‘minimum variance’, or ‘minimum volatility’ to ‘low volatility’.

2. LVPs achieve risk reduction of about 30%. Risk reduction varies between 15% to 45% across historical samples and economic regimes. Risk reduction is about 10% higher when currency risk is hedged and 10% lower when unhedged3. As equity risk is the most important risk factor for most portfolios, LVPs offer huge opportunities for significant downside risk reduction. This is possible while still maintaining full exposure to the equity risk premium in the long run.

3. LVPs profit from the oldest anomaly, but are also a relatively new phenomenon. The first academically documented alphas were found in low beta stocks as early as the 1970s. This low beta anomaly was discovered many years before the size, value and momentum effects were documented, and just a few years after the Capital Asset Pricing Model (CAPM) was developed.

4. LVPs' alpha is not the result of a magic formula, but is instead driven by persistent behavioral effects that cause markets to be inefficient. In the growing amount of literature on this subject, explanations for a structural alpha in low risk stocks are: (1) an increasing number of market participants focus on tracking error instead of total risk and from this perspective low risk stocks are ‘high risk’ and therefore unattractive. (2) Many investors are unwilling or unable to apply leverage in their portfolios. All else being equal, more balance sheet leverage leads to a higher expected equity returns, and so return-seeking investors tend to prefer high risk stocks. (3) The lottery ticket effect. A large number of risk-seeking investors buy volatile stocks to get rich quickly. (4) Attention bias. Stocks of companies which are in the news generate attention. This generally motivates investors to buy rather sell, as most investors own only a limited number of stocks and cannot easily sell a stock they do not own. (5) The winner’s curse. As a result of asymmetric information, the highest bidder often pays more for a stock than its true intrinsic value. The winner's curse applies more to highly volatile stocks than to stocks with low volatility4.

5. LVPs can be constructed with varying correlation dependence. A correlation estimate is unnecessary if stocks are sorted on total return volatility, but in practice correlations are taken into account and hybrid approaches are commonplace. The degree of correlation dependence should be managed in order to avoid the ‘maximizing errors’ problem, which tends to produce inefficient portfolios that require a lot of turnover. A literature survey shows that the different LVP approaches tend to produce similar levels of risk reduction and 30% turnover is enough to reduce risk5. Since correlations are not stable and risky low correlation stocks have low alphas we advise caution when using correlations6. All the currently available low volatility strategies successfully significantly reduce downside risk.

6. LVPs can also outperform during bull markets. A common misconception is to think that LVPs' low beta is a perfect predictor for future returns7. So if markets are expected to go up, then LVPs will underperform. In other words, the CAPM holds true. If this were the case, however, then LVPs would not contain alpha in the first place. This reasoning also implies that every investor with a bullish view on equities in general should not buy into LVPs, but just stick to high beta cyclical stocks and every investor with a more bearish view should abandon equities altogether.

7. LVPs generate huge tracking errors of 6-12% when compared to traditional market-capitalization weighted indices. But for other investment solutions which aim to reduce downside risk, such as put options, Constant Proportion Portfolio Insurance (CPPI) techniques or managed volatility products, nobody calculates the tracking errors. To stretch this argument to the extreme, consider a stock which is certain to generate 10% each year. For this stock the tracking error is equal to equity volatility of about 20%, but why would you care? In the end, absolute return per unit of risk is the objective of any strategy, including LVPs.

8. LVPs exhibit time-varying style exposures. LVPs had a value bias in 2006-2007, but this shifted to growth in 2008-2009. On average, value stocks tend to have lower risk, but since this risk tends to increase during recessions, LVPs are sometimes tilted to growth stocks, especially in periods of economic uncertainty. One could also say that value has a time-varying beta, which rises during bad times such as recessions and declines when the outlook is positive. Over the past few years we have written several papers on this topic.

9. LVPs tend to have somewhat higher interest rate sensitivity. Typically, when bond yields go down, low volatility stocks tend to outperform. This feature is particularly interesting for pension funds aiming to stabilize their coverage ratios. Since falling bond yields tends to reduce the coverage ratio, LVPs can be used as an indirect hedge.

10. The alpha of LVPs is very difficult to arbitrage away, in contrast to better known alphas such as value and momentum. Not all low-volatility stocks11 have the same alpha and ‘good’ low volatility stocks can significantly outperform ‘bad’ low volatility stocks. To catch the alpha in the low volatility segment of the stock market, either the market capitalization benchmark should be completely abolished and ignored, or the Strategic Asset Allocation (SAA) framework should be adjusted to include a separate style allocation to LVPs. In contrast to other alphas, the effect is also strong for large-cap stocks, stable across regions and has become stronger over the last few decades. I therefore believe that low volatility is a strong and significant anomaly that will continue to generate superior returns for a long time to come.
[1] Of course selfserving as they sell these "conservative" funds for a hefty fee.
[2] Click in the article if you want to look at their references.
Last edited by hdas on Fri Sep 20, 2019 1:16 pm, edited 1 time in total.
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Re: Things you should know about minimum volatility investing

Post by LadyGeek » Sun Feb 17, 2019 12:15 pm

This thread is now in the Investing - Theory, News & General forum (theory).
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Re: Things you should know about minimum volatility investing

Post by patrick013 » Sun Feb 17, 2019 3:13 pm

hdas wrote:
Sun Feb 17, 2019 11:37 am
from Robeco :

As a result, the name of this new emerging investment style evolved over time from ‘minimum variance’, or ‘minimum volatility’ to ‘low volatility’.
I think the low volatility comes from high earnings quality. Earnings not full of surprises, well predicted, stable, and somewhat rising earnings leading stock valuation to easy price stability. :)
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The Conservative Formula: Quantitative Investing Made Easy

Post by hdas » Thu Feb 21, 2019 4:35 pm

Read this instead of buying his book/pamphlet.
The Conservative Formula: Quantitative Investing Made Easy
21 Pages Posted: 21 Mar 2018
Pim van Vliet
Robeco Asset Management - Quantitative Investing

David Blitz
Robeco Asset Management - Quantitative Strategies

Date Written: March 21, 2018

Abstract
We propose a conservative investment formula which selects 100 stocks based on three criteria: low return volatility, high net payout yield, and strong price momentum. We show that this simple formula gives investors full and efficient exposure to the most important factor premiums, and thus effectively summarizes half a century of empirical asset pricing research into one easy to implement investment strategy. With a compounded annual return of 15.1 percent since 1929, the conservative formula outperforms the market by a wide margin. It reduces downside risk and shows a positive return over every decade. The formula is also strong in European, Japanese and Emerging stock markets, and beats a wide range of other strategies based on size, value, quality, and momentum combinations. The formula is designed to be a practically useful tool for a broad range of investors and addresses academic concerns about ‘p-hacking’ by using three simple criteria, which do not even require accounting data.
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Valuations and Future Factor Returns

Post by hdas » Wed Jul 17, 2019 9:41 am

Good Article:

Image

First, inherent characteristics of factors themselves have led to biases in valuation. Value, by definition, trades at a discount to the market, while quality, minimum volatility and momentum all tended to trade at a premium.

Second, an extremely low relative valuation might have historically helped explain the future performance of the value factor (and the yield factor to a certain degree). Intuitively, this makes sense. Investors need a valuation reference point to evaluate the premium they would receive as a result of taking on the added risk from those factors.

In contrast, valuations for the minimum volatility, momentum and quality factors have shown a weak relationship with subsequent performance. In general, investors have pursued strategies based on these factors because of inefficiencies resulting from behavioral biases than from relative valuation. Trying to use valuations to time those factors, at least historically, would have been a difficult exercise.

Third, using relative valuations to time an investment strategy would require both skill and an assumption that factors will always revert to a mean valuation within a specific time horizon. This is a tricky assumption to start with, as the composition of the factor indexes can differ significantly over time. As our previous research has shown, diversifying across factors historically has mitigated the risk of ups and downs in single factor performance in the absence of such skill and without perfect information.
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The Volatility Effect Revisited

Post by hdas » Tue Aug 27, 2019 10:50 am

Nice article from a not free of conflict party.
The Volatility Effect Revisited

David Blitz
Robeco

Pim van Vliet
Robeco Asset Management - Quantitative Investing

Guido Baltussen
Erasmus University Rotterdam (EUR); Robeco Asset Management - Quantitative Investing

Date Written: August 26, 2019

High-risk stocks do not have higher returns than low-risk stocks in all major stock markets. This paper provides a comprehensive overview of this low-risk effect, from the earliest asset pricing studies in the nineteen seventies to the most recent empirical findings and interpretations since. Volatility appears to be the main driver of the anomaly, which is highly persistent over time and across markets, and which cannot be explained by other factors such as value, profitability, or exposure to interest rate changes. From a practical perspective we argue that low-risk investing requires little turnover, that volatilities are more important than correlations, that low-risk indices are suboptimal and vulnerable to overcrowding, and that other factors can be efficiently integrated into a low-risk strategy. Finally, we find little evidence that the low-risk effect is being arbitraged away, as many investors are either neutrally positioned, or even on the other side of the low-risk trade.
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Re: Things you should know about minimum volatility investing

Post by Forester » Tue Aug 27, 2019 11:01 am

Until there's evidence to the contrary, min vol indexes are better market cap indexes. The construction is more "black box" than low vol, but look at the sector makeup, very balanced, unlike a low vol or value product, not piling into "loser" industries.

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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Aug 27, 2019 11:12 am

Low volatility stocks will likely remain low volatility stocks. We also know that historically such stocks have been outperforming the market. The risk isn't that these stocks will start becoming more volatile but that their performance premiums will disappear. Everyone and their brother now know about Low Volatility, everyone and their brother knows that interest rates are very low. Between investors performance chasing low volatility stocks and investors chasing yields (many low volatility stocks are higher dividend payers), it is hard to see how this premium in investment performance will continue. The risk is that these stocks will get too expensive. For example, do folks realize how expensive the consumer staples sector is compared to the market as a whole? Found this out when I bought Coke stock, high valuations gave me pause, I held my nose and bought anyway.
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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Aug 27, 2019 11:21 am

nedsaid wrote:
Tue Aug 27, 2019 11:12 am
Low volatility stocks will likely remain low volatility stocks. We also know that historically such stocks have been outperforming the market. The risk isn't that these stocks will start becoming more volatile but that their performance premiums will disappear. Everyone and their brother now know about Low Volatility, everyone and their brother knows that interest rates are very low. Between investors performance chasing low volatility stocks and investors chasing yields (many low volatility stocks are higher dividend payers), it is hard to see how this premium in investment performance will continue. The risk is that these stocks will get too expensive. For example, do folks realize how expensive the consumer staples sector is compared to the market as a whole? Found this out when I bought Coke stock, high valuations gave me pause, I held my nose and bought anyway.
With all due respect, you are just repeating the Swedroenian marketing. He missed this train. It's important to keep in mind that this basket has a lot more rotation. The implementation for the masses rebalances every 6 months, but nothing keeps you from doing it faster, in a portfolio of individual stocks. (use a tax advantaged account and free trades). Cheers :greedy
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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Aug 27, 2019 11:34 am

hdas wrote:
Tue Aug 27, 2019 11:21 am
nedsaid wrote:
Tue Aug 27, 2019 11:12 am
Low volatility stocks will likely remain low volatility stocks. We also know that historically such stocks have been outperforming the market. The risk isn't that these stocks will start becoming more volatile but that their performance premiums will disappear. Everyone and their brother now know about Low Volatility, everyone and their brother knows that interest rates are very low. Between investors performance chasing low volatility stocks and investors chasing yields (many low volatility stocks are higher dividend payers), it is hard to see how this premium in investment performance will continue. The risk is that these stocks will get too expensive. For example, do folks realize how expensive the consumer staples sector is compared to the market as a whole? Found this out when I bought Coke stock, high valuations gave me pause, I held my nose and bought anyway.
With all due respect, you are just repeating the Swedroenian marketing. He missed this train. It's important to keep in mind that this basket has a lot more rotation. The implementation for the masses rebalances every 6 months, but nothing keeps you from doing it faster, in a portfolio of individual stocks. (use a tax advantaged account and free trades). Cheers :greedy
No, I would say that part of this is influence from Larry and part of this is my own personal experience. When stocks get too expensive relative to their actual earning power, future returns are muted. I have posted many times about my "Four Horsemen of Underperformance", which were "must have" stocks from the 1990's but still too expensive when I bought them after the 2000-2002 bear market. The original four were AIG, GE, Microsoft, and Pfizer; all of which were bid up to unrealistic valuations during the 1990's. Of the four, only Microsoft turned out to be a good investment but even that was dead money for the first seven years I owned it. Also recall my comments about how expensive Coke and the entire Consumer Staples sector are.

I have nothing to sell here, I am not a Larry Swedroe or a Buckingham client. For the record, I invest differently than Larry does. So stop with the belittling remarks please. I do have a mind of my own and I can think for myself. Thank you.
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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Aug 27, 2019 11:58 am

nedsaid wrote:
Tue Aug 27, 2019 11:34 am
hdas wrote:
Tue Aug 27, 2019 11:21 am
nedsaid wrote:
Tue Aug 27, 2019 11:12 am
Low volatility stocks will likely remain low volatility stocks. We also know that historically such stocks have been outperforming the market. The risk isn't that these stocks will start becoming more volatile but that their performance premiums will disappear. Everyone and their brother now know about Low Volatility, everyone and their brother knows that interest rates are very low. Between investors performance chasing low volatility stocks and investors chasing yields (many low volatility stocks are higher dividend payers), it is hard to see how this premium in investment performance will continue. The risk is that these stocks will get too expensive. For example, do folks realize how expensive the consumer staples sector is compared to the market as a whole? Found this out when I bought Coke stock, high valuations gave me pause, I held my nose and bought anyway.
With all due respect, you are just repeating the Swedroenian marketing. He missed this train. It's important to keep in mind that this basket has a lot more rotation. The implementation for the masses rebalances every 6 months, but nothing keeps you from doing it faster, in a portfolio of individual stocks. (use a tax advantaged account and free trades). Cheers :greedy
No, I would say that part of this is influence from Larry and part of this is my own personal experience. When stocks get too expensive relative to their actual earning power, future returns are muted. I have posted many times about my "Four Horsemen of Underperformance", which were "must have" stocks from the 1990's but still too expensive when I bought them after the 2000-2002 bear market. The original four were AIG, GE, Microsoft, and Pfizer; all of which were bid up to unrealistic valuations during the 1990's. Of the four, only Microsoft turned out to be a good investment but even that was dead money for the first seven years I owned it. Also recall my comments about how expensive Coke and the entire Consumer Staples sector are.

I have nothing to sell here, I am not a Larry Swedroe or a Buckingham client. For the record, I invest differently than Larry does. So stop with the belittling remarks please. I do have a mind of my own and I can think for myself. Thank you.
I apologize for the style of the comment. I do value your opinion. However, you are missing the gist of the argument, say the low vol stocks of today are really expensive, and they start to go down, as they go down their volatilities go up and they get discarded from the basket and replace by a new set of low vol stocks. I grant you that the key is the implementation. I expect USMV to do this process ok (given the size of the fund). Cheers :greedy
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Re: Things you should know about minimum volatility investing

Post by nisiprius » Tue Aug 27, 2019 11:59 am

hdas wrote:
Sun Feb 17, 2019 11:37 am
I found this good precis from Robeco [1][2]:...
LVPs offer huge opportunities for significant downside risk reduction. This is possible while still maintaining full exposure to the equity risk premium in the long run...
This isn't explained in the article. What is the basis for thinking that these stocks give "full exposure to the equity risk premium in the long run?"
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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Aug 27, 2019 12:13 pm

hdas wrote:
Tue Aug 27, 2019 11:58 am
nedsaid wrote:
Tue Aug 27, 2019 11:34 am
hdas wrote:
Tue Aug 27, 2019 11:21 am
nedsaid wrote:
Tue Aug 27, 2019 11:12 am
Low volatility stocks will likely remain low volatility stocks. We also know that historically such stocks have been outperforming the market. The risk isn't that these stocks will start becoming more volatile but that their performance premiums will disappear. Everyone and their brother now know about Low Volatility, everyone and their brother knows that interest rates are very low. Between investors performance chasing low volatility stocks and investors chasing yields (many low volatility stocks are higher dividend payers), it is hard to see how this premium in investment performance will continue. The risk is that these stocks will get too expensive. For example, do folks realize how expensive the consumer staples sector is compared to the market as a whole? Found this out when I bought Coke stock, high valuations gave me pause, I held my nose and bought anyway.
With all due respect, you are just repeating the Swedroenian marketing. He missed this train. It's important to keep in mind that this basket has a lot more rotation. The implementation for the masses rebalances every 6 months, but nothing keeps you from doing it faster, in a portfolio of individual stocks. (use a tax advantaged account and free trades). Cheers :greedy
No, I would say that part of this is influence from Larry and part of this is my own personal experience. When stocks get too expensive relative to their actual earning power, future returns are muted. I have posted many times about my "Four Horsemen of Underperformance", which were "must have" stocks from the 1990's but still too expensive when I bought them after the 2000-2002 bear market. The original four were AIG, GE, Microsoft, and Pfizer; all of which were bid up to unrealistic valuations during the 1990's. Of the four, only Microsoft turned out to be a good investment but even that was dead money for the first seven years I owned it. Also recall my comments about how expensive Coke and the entire Consumer Staples sector are.

I have nothing to sell here, I am not a Larry Swedroe or a Buckingham client. For the record, I invest differently than Larry does. So stop with the belittling remarks please. I do have a mind of my own and I can think for myself. Thank you.
I apologize for the style of the comment. I do value your opinion. However, you are missing the gist of the argument, say the low vol stocks of today are really expensive, and they start to go down, as they go down their volatilities go up and they get discarded from the basket and replace by a new set of low vol stocks. I grant you that the key is the implementation. I expect USMV to do this process ok (given the size of the fund). Cheers :greedy
What is likely to happen is that Low Volatility stocks will continue to be Low Volatility stocks, remaining in the basket. The problem is when the basket itself gets to be too expensive. Now you could screen Low Volatility stocks for Value and mitigate the pricing risk I discussed above, but I suspect you would have a much smaller basket. Not sure volatility will go up simply because price goes up, people who believe the "Low Volatility Religion" will continue to buy such stocks even at elevated prices. The "religion" will break if at some point Low Volatility stocks seriously underperform the market for extended periods of time. So far, this hasn't happened.
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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Aug 27, 2019 12:15 pm

nisiprius wrote:
Tue Aug 27, 2019 11:59 am
hdas wrote:
Sun Feb 17, 2019 11:37 am
I found this good precis from Robeco [1][2]:...
LVPs offer huge opportunities for significant downside risk reduction. This is possible while still maintaining full exposure to the equity risk premium in the long run...
This isn't explained in the article. What is the basis for thinking that these stocks give "full exposure to the equity risk premium in the long run?"
Because of the empirical distribution of upside/downside capture relative to TSM. But I imagine your question goes beyond and really is: why does this anomaly persist?....this is a big question, I will point you to a reference to start looking into, a short answer is that ppl can't help themselves a longer answer includes (i) constraints, (ii) relative performance objectives, (iii) agency issues, (iv) skewness preference, and (v) behavioral biases.

Cheers :greedy
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Re: Things you should know about minimum volatility investing

Post by Forester » Tue Aug 27, 2019 12:19 pm

Low / min vol is potentially more robust than value or US vs ex-US since it is not relying on a narrative to play out, it is price-based and remorselessly rebalances to keep the low vol characteristic. In this regard it's similar to momentum albeit with much less turnover.

Hypothetically if a low vol stock began to experience market turmoil due to its hefty valuation it would be turfed out of the index before too much harm could be done :idea:

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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Aug 27, 2019 12:21 pm

nedsaid wrote:
Tue Aug 27, 2019 12:13 pm

What is likely to happen is that Low Volatility stocks will continue to be Low Volatility stocks, remaining in the basket.
This is conditional on the implementation. As a blanket statement is just false.
nedsaid wrote:
Tue Aug 27, 2019 12:13 pm
Not sure volatility will go up simply because price goes up, people who believe the "Low Volatility Religion" will continue to buy such stocks even at elevated prices.
You are getting it backwards, I said: Volatility will go up if when those stocks go down, specially if they go down more than the market. The likely scenario is that the market will become greedy and high beta will outperform low beta, this will happen in a 98-00 risk on environment. People will feel dumb holding the safe stocks and the cycle starts again, the anomaly persists.
nedsaid wrote:
Tue Aug 27, 2019 12:13 pm
The "religion" will break if at some point Low Volatility stocks seriously underperform the market for extended periods of time. So far, this hasn't happened.
This is really misguided, if there's an anomaly that any person with some computer skills and a good dataset can research for themselves is this one. The empirical evidence is undeniable, no guarantees in the future. The "religion" moniker really does not apply.

Cheers :greedy
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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Aug 27, 2019 12:37 pm

hdas wrote:
Tue Aug 27, 2019 12:21 pm
nedsaid wrote:
Tue Aug 27, 2019 12:13 pm

What is likely to happen is that Low Volatility stocks will continue to be Low Volatility stocks, remaining in the basket.
This is conditional on the implementation. As a blanket statement is just false.
nedsaid wrote:
Tue Aug 27, 2019 12:13 pm
Not sure volatility will go up simply because price goes up, people who believe the "Low Volatility Religion" will continue to buy such stocks even at elevated prices.
You are getting it backwards, I said: Volatility will go up if when those stocks go down, specially if they go down more than the market. The likely scenario is that the market will become greedy and high beta will outperform low beta, this will happen in a 98-00 risk on environment. People will feel dumb holding the safe stocks and the cycle starts again, the anomaly persists.
nedsaid wrote:
Tue Aug 27, 2019 12:13 pm
The "religion" will break if at some point Low Volatility stocks seriously underperform the market for extended periods of time. So far, this hasn't happened.
This is really misguided, if there's an anomaly that any person with some computer skills and a good dataset can research for themselves is this one. The empirical evidence is undeniable, no guarantees in the future. The "religion" moniker really does not apply.

Cheers :greedy
Yes, the "religion" moniker does apply. I have seen this at work, particularly during the 1990's. It seemed like whole "denominations" grew around each of the "must have" stocks of the 1990's. You sort of had a "Church of GE", a "Church of Coke", and "Church of Pfizer", etc. The belief in these stocks got to be so high that people wouldn't look at contrary evidence. I remember the little research articles I would get from PaineWebber, discussing the "Ruler Stocks", stocks with consistent 15% annual earnings growth that you could draw with a ruler. Trouble was, it was all baloney, the organic earnings growth rate of the underlying businesses were probably more like 6% to 8%. Also, in real life, business fluctuates. You can't draw earnings growth with a ruler. There was a whole lot of financial engineering going on to support those 15% annual growth numbers and to make those numbers look smoother than they really were. When an analyst would doubt Coke's alleged growth rates, the Coke CEO would call and berate the analyst into submission. Hard for firms to buck this as they didn't want to lose the underwriting business in case these companies wanted to float more debt or more stock.

People can believe in certain Low Volatility stocks to the point it becomes a religion. Folks are buying them because they performed well in the past and experienced lower than market volatility in the past. It takes a while for such strongly rooted beliefs to change. I wouldn't take it for granted that higher prices will mean higher volatility. More likely you would get subdued returns in the future.

I also want to point out that Low Volatility and Value are two different things. Foggy memory from Larry's writings say that Low Vol is in the Value sector about 60% of the time. When Low Vol is in the Value sector it tends to outperform, when it gets into the Growth sector it tends to underperform. There was a time in the not so distant past when Low Volatility stocks were valued like Growth stocks. Low Vol and Value are different things but there is overlap just as there is with Large Value and High Dividend. Often there is a Large Value/High Dividend/Low Volatility overlap; not so much the case right now.

My guess is that over long periods of time, that the effect of the Low Volatility factor will persist, my thesis is that factors are largely grounded in human nature, human behavior, and human preferences. What I have been saying here is that the Low Volatility trade is overgrazed, folks who pile into such stocks will likely experience subdued returns over shorter time periods. Longer run, the Low Volatility premium should persist but obviously no guarantees. Valuations matter and matter a lot.

I have been at this for a lot of years and know some things about the markets and how this stuff works. Don't appreciate your continuing belittling comments.
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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Aug 27, 2019 1:20 pm

nedsaid wrote:
Tue Aug 27, 2019 12:37 pm

My guess is that over long periods of time, that the effect of the Low Volatility factor will persist, my thesis is that factors are largely grounded in human nature, human behavior, and human preferences. What I have been saying here is that the Low Volatility trade is overgrazed, folks who pile into such stocks will likely experience subdued returns over shorter time periods. Longer run, the Low Volatility premium should persist but obviously no guarantees.
On this we agree :sharebeer
nedsaid wrote:
Tue Aug 27, 2019 12:37 pm

I have been at this for a lot of years and know some things about the markets and how this stuff works. Don't appreciate your continuing belittling comments.
I'm sorry you feel this way, It was not my intention.

Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Aug 27, 2019 1:32 pm

hdas wrote:
Tue Aug 27, 2019 1:20 pm
nedsaid wrote:
Tue Aug 27, 2019 12:37 pm

My guess is that over long periods of time, that the effect of the Low Volatility factor will persist, my thesis is that factors are largely grounded in human nature, human behavior, and human preferences. What I have been saying here is that the Low Volatility trade is overgrazed, folks who pile into such stocks will likely experience subdued returns over shorter time periods. Longer run, the Low Volatility premium should persist but obviously no guarantees.
On this we agree :sharebeer
nedsaid wrote:
Tue Aug 27, 2019 12:37 pm

I have been at this for a lot of years and know some things about the markets and how this stuff works. Don't appreciate your continuing belittling comments.
I'm sorry you feel this way, It was not my intention.

Cheers :greedy
Thanks for your comments. We are looking at the same thing from different angles.

I am not saying Low Volatility is a bad strategy, just saying the timing isn't the best right now. My expectation is that the premium will persist over very long time periods.

Markets are dynamic, it could be that this Low Volatility premium will be taken away from us permanently. So far, the premium has persisted even at elevated valuations. What Larry has warned about hasn't happened yet, Low Volatility has continued to perform well. At some point though, valuations still matter. My eyeballing perceives that the valuation story for Low Volatility is better now than it was a couple of years ago but these stocks are still relatively expensive compared to the market itself. Just look at the Consumer Staples sector.

My thesis is that expensive can stay expensive and even get more expensive. Hence, the "religion" that I discuss above. Folks just get to where they have a blind eye towards contrary evidence. At some point, the markets will discover that slow growth stocks should not command similar P/E ratios to higher growth stocks. In the case of my "Four Horsemen of Underperformance", it took a while for markets to realize, even after the 2000-2002 bear market, that the expectations for the "must have" or "ruler" stocks of the 1990's were just too high. In the case of my four stocks, it took at least 5-7 years, and that was after the 2000-2002 bear market. Incorrect but strong beliefs take years to die off even in the light of mountains of evidence. Such is the power of denial, and I don't mean a river in Egypt.
A fool and his money are good for business.

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Re: Things you should know about minimum volatility investing

Post by hdas » Tue Sep 03, 2019 3:33 pm

One of the things that Swedroe says that makes little to no sense is the idea that you massage the data to explain the low vol anomaly with 3 factors. Instead of highlighting the fact that the low vol anomaly is robust and you need 3 factors to explain it. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by G12 » Tue Sep 03, 2019 4:39 pm

nedsaid wrote:
Tue Aug 27, 2019 1:32 pm
Thanks for your comments. We are looking at the same thing from different angles.

I am not saying Low Volatility is a bad strategy, just saying the timing isn't the best right now. My expectation is that the premium will persist over very long time periods.

Markets are dynamic, it could be that this Low Volatility premium will be taken away from us permanently. So far, the premium has persisted even at elevated valuations. What Larry has warned about hasn't happened yet, Low Volatility has continued to perform well. At some point though, valuations still matter. My eyeballing perceives that the valuation story for Low Volatility is better now than it was a couple of years ago but these stocks are still relatively expensive compared to the market itself. Just look at the Consumer Staples sector.

My thesis is that expensive can stay expensive and even get more expensive. Hence, the "religion" that I discuss above. Folks just get to where they have a blind eye towards contrary evidence. At some point, the markets will discover that slow growth stocks should not command similar P/E ratios to higher growth stocks. In the case of my "Four Horsemen of Underperformance", it took a while for markets to realize, even after the 2000-2002 bear market, that the expectations for the "must have" or "ruler" stocks of the 1990's were just too high. In the case of my four stocks, it took at least 5-7 years, and that was after the 2000-2002 bear market. Incorrect but strong beliefs take years to die off even in the light of mountains of evidence. Such is the power of denial, and I don't mean a river in Egypt.
I understand your take and outlook, yet the most recent report I found for VMNVX was April 30, 2019 which indicated consumer staples comprised 12.1% of holdings, followed closely by consumer discretionary at 11.9%. This fund is my largest equity holding, yet I do own multiple other ETFs and funds, so I am not betting the house on long term performance of just min vol strategy. I have been in VMNVX since about 4 weeks after it became available. O&G are the smallest sector holding of this fund at 1.5%, for good reason, yet I do have O&G holdings, so maybe I am defeating the min vol exposure... :shock: :wink: The one thing regarding the fund that continues to surprise me is the relatively low market cap of its total constituents. Behaviorally, min vol may help investors remain invested in poor equity markets, maybe not.

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Re: Things you should know about minimum volatility investing

Post by nedsaid » Tue Sep 03, 2019 7:48 pm

G12 wrote:
Tue Sep 03, 2019 4:39 pm
nedsaid wrote:
Tue Aug 27, 2019 1:32 pm
Thanks for your comments. We are looking at the same thing from different angles.

I am not saying Low Volatility is a bad strategy, just saying the timing isn't the best right now. My expectation is that the premium will persist over very long time periods.

Markets are dynamic, it could be that this Low Volatility premium will be taken away from us permanently. So far, the premium has persisted even at elevated valuations. What Larry has warned about hasn't happened yet, Low Volatility has continued to perform well. At some point though, valuations still matter. My eyeballing perceives that the valuation story for Low Volatility is better now than it was a couple of years ago but these stocks are still relatively expensive compared to the market itself. Just look at the Consumer Staples sector.

My thesis is that expensive can stay expensive and even get more expensive. Hence, the "religion" that I discuss above. Folks just get to where they have a blind eye towards contrary evidence. At some point, the markets will discover that slow growth stocks should not command similar P/E ratios to higher growth stocks. In the case of my "Four Horsemen of Underperformance", it took a while for markets to realize, even after the 2000-2002 bear market, that the expectations for the "must have" or "ruler" stocks of the 1990's were just too high. In the case of my four stocks, it took at least 5-7 years, and that was after the 2000-2002 bear market. Incorrect but strong beliefs take years to die off even in the light of mountains of evidence. Such is the power of denial, and I don't mean a river in Egypt.
I understand your take and outlook, yet the most recent report I found for VMNVX was April 30, 2019 which indicated consumer staples comprised 12.1% of holdings, followed closely by consumer discretionary at 11.9%. This fund is my largest equity holding, yet I do own multiple other ETFs and funds, so I am not betting the house on long term performance of just min vol strategy. I have been in VMNVX since about 4 weeks after it became available. O&G are the smallest sector holding of this fund at 1.5%, for good reason, yet I do have O&G holdings, so maybe I am defeating the min vol exposure... :shock: :wink: The one thing regarding the fund that continues to surprise me is the relatively low market cap of its total constituents. Behaviorally, min vol may help investors remain invested in poor equity markets, maybe not.
My comments relate to Minimum Volatility here in the United States. The Vanguard fund you mention is a Global Fund and it also seems to have a lot of Mid-Caps in it. Here in the US, Minimum Volatility seems more associated with Large Caps though there isn't any reason one could include a lot of Mid-Caps. A good question to pose to somebody like Larry is the connection between trading volume and Low Volatility. It seems you would want a certain amount of trading volume and it would seem to work best with Large Caps, I suspect market impact from trades is a possible reason.
Also with Large Caps, less chance of liquidity drying up in a crisis. It seems that a potential lack of liquidity in a crisis could create the very volatility problem you are trying to avoid.
A fool and his money are good for business.

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Re: Things you should know about minimum volatility investing

Post by stlutz » Tue Sep 03, 2019 8:59 pm

I think right now the best strategy in the space is to invest in the low volatility stocks that are not currently owned by USMV, at least in a substantial way.

That ETF has become so dominant in this space that the index changes on the underlying index do have a market impact. I think it was Robeco who had a whitepaper once showing their was already a market impact cost on stocks being added to the MSCI Min Vol index before USMV took off (meaning that other institutional investors were following the index with significant dollars).

If one doesn't go the individual stock route, using the Vanguard fund/ETF may be the way to go with now with the active management overlay.

Does anyone want to argue that there is a significant cohort of investors who *should* prefer high volatility stocks? That's how you get an anomaly like this that you know can persist.

Erik Falkenstein argued that in his Missing Risk Premium book, under the idea that risk is (and not mistakenly perceived to be) relative. Essentially the argument there is that you could buy low volatility stocks and end up richer than high vol guy, but he'll end up happier. It was an interesting idea but not one that he explored in any detail (and I haven't seen anyone else propose it either).

I've had rather token allocation to USMV in my portfolio for a long time now and it's done extremely well in the time I've owned it, but if investors really have changed their risk preferences in equities then that performance is not going to be repeated in the future. And you would need a very different type of bull market than we have had the past 10 years to get there.

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Re: Things you should know about minimum volatility investing

Post by HEDGEFUNDIE » Tue Sep 03, 2019 9:45 pm

stlutz wrote:
Tue Sep 03, 2019 8:59 pm
I think right now the best strategy in the space is to invest in the low volatility stocks that are not currently owned by USMV, at least in a substantial way.

That ETF has become so dominant in this space that the index changes on the underlying index do have a market impact. I think it was Robeco who had a whitepaper once showing their was already a market impact cost on stocks being added to the MSCI Min Vol index before USMV took off (meaning that other institutional investors were following the index with significant dollars).

If one doesn't go the individual stock route, using the Vanguard fund/ETF may be the way to go with now with the active management overlay.

Does anyone want to argue that there is a significant cohort of investors who *should* prefer high volatility stocks? That's how you get an anomaly like this that you know can persist.

Erik Falkenstein argued that in his Missing Risk Premium book, under the idea that risk is (and not mistakenly perceived to be) relative. Essentially the argument there is that you could buy low volatility stocks and end up richer than high vol guy, but he'll end up happier. It was an interesting idea but not one that he explored in any detail (and I haven't seen anyone else propose it either).

I've had rather token allocation to USMV in my portfolio for a long time now and it's done extremely well in the time I've owned it, but if investors really have changed their risk preferences in equities then that performance is not going to be repeated in the future. And you would need a very different type of bull market than we have had the past 10 years to get there.
Another great strategy is to go international - EFAV has offered a nice return over the plain EAFE index since inception.

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Re: Things you should know about minimum volatility investing

Post by countmein » Tue Sep 03, 2019 9:53 pm

I'm wondering why low vol is considered expensive. Based on what metrics? I hear this asserted ad nauseum but don't know how I can verify this for myself.

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Re: Things you should know about minimum volatility investing

Post by stlutz » Tue Sep 03, 2019 11:33 pm

countmein wrote:
Tue Sep 03, 2019 9:53 pm
I'm wondering why low vol is considered expensive. Based on what metrics? I hear this asserted ad nauseum but don't know how I can verify this for myself.
I usually just look at etf.com to compare PE ratios. I like etf.com because they aggregate all of the companies together as if they were a single company as opposed to just looking at the median stock or something like that.

Results:

USMV: 27.73
ITOT: 24.53

So, USMV is currently about 13% more expensive than the market as a whole.

BTW, much less expensive than small value. IJS trades at a multiple of 43.99.

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Re: Things you should know about minimum volatility investing

Post by Forester » Wed Sep 04, 2019 2:56 am

Also worth bearing in mind, would many of the lower PE yet more volatile stocks that have been screened out, be worth owning? Lots of Gamestop value traps and so on. Low vol will lag when the market does 20%+ and hold up better when there's economic stress, sounds like a good deal to me.

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Re: Things you should know about minimum volatility investing

Post by hdas » Wed Sep 04, 2019 10:15 am

countmein wrote:
Tue Sep 03, 2019 9:53 pm
I'm wondering why low vol is considered expensive. Based on what metrics? I hear this asserted ad nauseum but don't know how I can verify this for myself.
You can’t, unless you master the art/science of valuation. OTOH, if you want to use the naive metrics that have been misleading people for the last 10 years, go ahead and start looking at the silly ratios. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by Forester » Wed Sep 04, 2019 12:49 pm

I think we're due a rebound in SPY vs USMV, SPLV etc, similar to 2016/17. I'm staying the course! Min vol is momentum for high IQ folk.

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Re: Things you should know about minimum volatility investing

Post by countmein » Wed Sep 04, 2019 1:30 pm

stlutz wrote:
Tue Sep 03, 2019 11:33 pm
countmein wrote:
Tue Sep 03, 2019 9:53 pm
I'm wondering why low vol is considered expensive. Based on what metrics? I hear this asserted ad nauseum but don't know how I can verify this for myself.
I usually just look at etf.com to compare PE ratios. I like etf.com because they aggregate all of the companies together as if they were a single company as opposed to just looking at the median stock or something like that.

Results:

USMV: 27.73
ITOT: 24.53

So, USMV is currently about 13% more expensive than the market as a whole.

BTW, much less expensive than small value. IJS trades at a multiple of 43.99.
Thanks for pointing this out, I wasn't aware of this idea of P/E = Sum(P) / Sum(E) as an alternative to the standard(?) P/E = Sum(P/E).

It's very interesting as the two methods yield wildly different results (e.g. RZV's P/E = -30 on ETF.com, +10 on M*).

Why do you prefer ETF.com's calculations?

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Re: Things you should know about minimum volatility investing

Post by countmein » Wed Sep 04, 2019 4:30 pm

Found this thread on the P/E topic:
viewtopic.php?t=226217

After some thought, I agree that ETF.com / S&P are doing it the right way because they don't arbitrarily throw out negative earnings (that anybody would discard those stocks from the calculation is unbelievable to me).

However, when a fund's P/E goes negative, it's essentially meaningless from a quantitative standpoint, but qualitatively meaningful, as in: hey, you're paying good money for less than zero earnings!

This negative earnings thing is pretty weird. IWC, iShares Micro Cap, has a -15 P/E. Therefore, all of the microcap stocks, in aggregate, are losing money (yikes). But according to M*, IWC has got a robust expected return with a P/E of 13. So what's my expected return? Squat? or 1/13 = 7.5% ?

Sorry for completely hijaking this thread.

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IS LOW VOL THE NEW VALUE?

Post by hdas » Mon Sep 16, 2019 3:11 pm

Semi-interesting article in the factor research blog:
SUMMARY

The Low Volatility factor exhibited significant exposure to Value since 1989
The factors were highly correlated in the 1990s, but less after the financial crisis
Quantitative easing was positive for Low Volatility, but negative for Value
Image

Image

Cheers :greedy
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LOW VOL FACTOR

Post by hdas » Fri Sep 20, 2019 1:18 pm

Here's the Low-High Vol deciles since 1929. Long live the anomaly!!

Image

Cheers :greedy
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Low Volatility Needs Little Trading

Post by hdas » Mon Sep 23, 2019 11:55 am

Source
Abstract

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.
Cheers :greedy
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Re: IS LOW VOL THE NEW VALUE?

Post by Forester » Mon Sep 23, 2019 2:36 pm

hdas wrote:
Mon Sep 16, 2019 3:11 pm
Semi-interesting article in the factor research blog:
"On the other hand, investors buying low-risk stocks are hoping for equity-like returns with a reduced downside. These are two fundamentally different investment philosophies."

I don't think he likes low vol. Screening out the volatile stocks, low turnover, is boring (and works). An obvious problem I can see with articles like this, is that the hypothetical portfolio is not sector neutral. The largest low vol fund in the world is USMV, its sector weights don't deviate enormously from the S&P 500.

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Re: IS LOW VOL THE NEW VALUE?

Post by hdas » Mon Sep 23, 2019 4:01 pm

Forester wrote:
Mon Sep 23, 2019 2:36 pm
hdas wrote:
Mon Sep 16, 2019 3:11 pm
Semi-interesting article in the factor research blog:
"On the other hand, investors buying low-risk stocks are hoping for equity-like returns with a reduced downside. These are two fundamentally different investment philosophies."

I don't think he likes low vol. Screening out the volatile stocks, low turnover, is boring (and works). An obvious problem I can see with articles like this, is that the hypothetical portfolio is not sector neutral. The largest low vol fund in the world is USMV, its sector weights don't deviate enormously from the S&P 500.
You are right, most value people don't like low vol.....the risk paradox makes them uncomfortable as it undermines a bit their risk based explanations. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by Northern Flicker » Mon Sep 23, 2019 7:58 pm

Good info overall but the following ranges from unsubstantiated theory to hogwash:
4. LVPs' alpha is not the result of a magic formula, but is instead driven by persistent behavioral effects that cause markets to be inefficient. In the growing amount of literature on this subject, explanations for a structural alpha in low risk stocks are: (1) an increasing number of market participants focus on tracking error instead of total risk and from this perspective low risk stocks are ‘high risk’ and therefore unattractive. (2) Many investors are unwilling or unable to apply leverage in their portfolios. All else being equal, more balance sheet leverage leads to a higher expected equity returns, and so return-seeking investors tend to prefer high risk stocks. (3) The lottery ticket effect.
Index fund investors are not exercising these behavioral issues despite not choosing to tilt to low volume stocks.

They also minimize the term exposure and discuss lots of other stuff. Might this be an asset mgr promoting a particular low volatility product?
Risk is not a guarantor of return.

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Re: Things you should know about minimum volatility investing

Post by Forester » Sat Oct 05, 2019 4:55 am

Tumultuous week, USMV +0.36%, S&P500 bagholders -0.33%

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Re: Things you should know about minimum volatility investing

Post by hdas » Wed Oct 09, 2019 4:31 pm

Northern Flicker wrote:
Mon Sep 23, 2019 7:58 pm
Good info overall but the following ranges from unsubstantiated theory to hogwash:
4. LVPs' alpha is not the result of a magic formula, but is instead driven by persistent behavioral effects that cause markets to be inefficient. In the growing amount of literature on this subject, explanations for a structural alpha in low risk stocks are: (1) an increasing number of market participants focus on tracking error instead of total risk and from this perspective low risk stocks are ‘high risk’ and therefore unattractive. (2) Many investors are unwilling or unable to apply leverage in their portfolios. All else being equal, more balance sheet leverage leads to a higher expected equity returns, and so return-seeking investors tend to prefer high risk stocks. (3) The lottery ticket effect.
Index fund investors are not exercising these behavioral issues despite not choosing to tilt to low volume stocks.

They also minimize the term exposure and discuss lots of other stuff. Might this be an asset mgr promoting a particular low volatility product?
The question is why do you want high beta junk in your index fund?. Cheers :greedy (Check SPHB)
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by GaryA505 » Sat Oct 12, 2019 10:21 pm

I've wondered if a portfolio of 50% VMNVX (Vanguard Global Minimum Volatility) and 50% short-term treasuries (or CDs, TIPS, etc.) wouldn't make a dandy retirement portfolio. Just take the RMD (or whatever) out of the highest one each year and do any additional balancing required.

To be clear, I'm just throwing this out there and this isn't my portfolio, though I do have a pretty good percentage of my equity side in VMNVX.

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Re: Things you should know about minimum volatility investing

Post by hdas » Wed Oct 16, 2019 10:08 am

GaryA505 wrote:
Sat Oct 12, 2019 10:21 pm
I've wondered if a portfolio of 50% VMNVX (Vanguard Global Minimum Volatility) and 50% short-term treasuries (or CDs, TIPS, etc.) wouldn't make a dandy retirement portfolio. Just take the RMD (or whatever) out of the highest one each year and do any additional balancing required.

To be clear, I'm just throwing this out there and this isn't my portfolio, though I do have a pretty good percentage of my equity side in VMNVX.
It would, if you can handle the underperformance during the exuberant part of the cycle. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Things you should know about minimum volatility investing

Post by Forester » Wed Oct 16, 2019 10:27 am

GaryA505 wrote:
Sat Oct 12, 2019 10:21 pm
I've wondered if a portfolio of 50% VMNVX (Vanguard Global Minimum Volatility) and 50% short-term treasuries (or CDs, TIPS, etc.) wouldn't make a dandy retirement portfolio. Just take the RMD (or whatever) out of the highest one each year and do any additional balancing required.

To be clear, I'm just throwing this out there and this isn't my portfolio, though I do have a pretty good percentage of my equity side in VMNVX.
If we had another period such as the late 1990s, this would lag badly. Some MTUM/IMTM would remedy that.

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Re: Things you should know about minimum volatility investing

Post by GaryA505 » Wed Oct 16, 2019 10:55 am

hdas wrote:
Wed Oct 16, 2019 10:08 am
GaryA505 wrote:
Sat Oct 12, 2019 10:21 pm
I've wondered if a portfolio of 50% VMNVX (Vanguard Global Minimum Volatility) and 50% short-term treasuries (or CDs, TIPS, etc.) wouldn't make a dandy retirement portfolio. Just take the RMD (or whatever) out of the highest one each year and do any additional balancing required.

To be clear, I'm just throwing this out there and this isn't my portfolio, though I do have a pretty good percentage of my equity side in VMNVX.
It would, if you can handle the underperformance during the exuberant part of the cycle. Cheers :greedy
Maybe I'm just different, but underperformance in a bull market doesn't bother me as much as the loss of value during a bear. I look at the bigger picture. :wink:

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