- There are two schools of thought when it comes to volatility and investment returns: the classical view and the low-volatility anomaly.
- The classical view suggests that greater risk leads to greater rewards, while the low-volatility anomaly argues that lower risk can result in higher returns.
- A study of mutual funds and ETFs over the past decade shows that high-volatility funds have outperformed low-volatility funds in terms of returns.
- US high-volatility funds had an average annualized post-tax return of 15.89% over the past 10 years, compared to 5.16% for low-volatility funds.
- Similar results were found in international and emerging markets, with high-volatility funds outperforming their low-volatility counterparts.
- Even compared to a broad market index like the S&P 500, low-volatility funds have underperformed in terms of returns.
- It remains to be seen whether this trend will continue or if it was an anomaly.
When it comes to the relationship between volatility and investment returns, there are two schools of thought in finance. The classical view suggests that greater risk is associated with greater potential rewards. This means that a portfolio with a higher level of risk may generate higher returns over the long term. On the other hand, the low-volatility anomaly argues that lower risk, or volatility, can lead to higher anticipated returns.
The low-volatility anomaly has gained attention in recent years, leading to the introduction of hundreds of exchange-traded funds (ETFs) and mutual funds that aim to minimize volatility in equity portfolios. These funds focus on selecting securities with lower volatility in an effort to achieve higher returns.
To determine whether low-volatility or high-volatility strategies offer the highest returns, a study was conducted using Morningstar Direct data. The study analyzed the returns of all low- and high-volatility equity mutual funds and ETFs over the past decade. The performance data of US dollar-denominated equity funds with objectives of either minimizing volatility or investing in high-volatility stocks was collected.
The results of the study were clear and unequivocal. US high-volatility funds performed significantly better than their low-volatility counterparts. On a post-tax basis, the average high-volatility fund achieved an annualized return of 15.89% over the past 10 years, compared to just 5.16% for the average low-beta fund.
The outperformance of high-volatility funds was also observed in international and emerging markets. In low-volatility international stocks, the average post-tax annual return was 2.51% over the past 10 years, while high-volatility funds achieved a return of 5.81% over the same period. In emerging markets, high-beta funds outperformed low-beta funds with returns of 4.55% compared to 0.11% over the last decade.
It is worth noting that most low-volatility funds did not even match the performance of a broad market index like the S&P 500. Over the past five and 10 years, the average S&P 500 focused mutual fund or ETF delivered annual returns of 11.72% and 10.67%, respectively, exceeding the performance of low-volatility funds.
While these findings highlight the outperformance of high-volatility funds in recent years, it remains to be seen whether this trend will continue or if it was an anomaly. Investors should monitor this development closely.
In conclusion, the study indicates that high-volatility mutual funds and ETFs have generated considerably higher returns over the past decade compared to low-volatility funds. However, it is important to note that these findings are based on historical data and do not guarantee future performance. Investors should carefully consider their risk tolerance and investment objectives before making any investment decisions.
