Low volatility and high quality

Low Risk Stocks Outperform within All Observable Markets of the World is an interesting paper from earlier this year that I’ve belatedly got round to reading. Co-written by Robert Haugen, one of the pioneering figures in quantitative investing, it focuses on the low volatility anomaly, which is the evidence that low volatility stocks on average produce higher returns than high volatility ones

The low volatility anomaly goes against conventional financial theory, which states that more volatile stocks should outperform since they are riskier. Haugen was one of the first researchers to show decades ago that empirical data in the USA did not support this idea and data in this newer paper essentially updates that. It looks at 21 developed markets and 12 emerging markets since 1990 and shows that low volatility stocks have consistently outperformed in all of these.

Of course, the interesting question is why this anomaly persists. Haugen and his co-author Nardin Baker propose what is essentially a behavioural and agency-based explanation, revolving around perceived incentives for the investment management industry to favour more volatile stocks.