Low-volatility stocks have become the market’s hot sellers. In fact, there are now exchange-traded funds full of stocks with good relative price stability and market indices measuring both high-volatility and low-volatility portfolios.
This excitement stems from recent investment research. But this research only validates much earlier work. In 1959, Arnold Bernhard reported on how stocks with superior price stability were the highest-quality stocks. He had proven this performance in the New York-based Value Line Investment Survey, a newsletter he founded in 1937. And in 1995, Robert Haugen, professor of finance at the University of California, Irvine, showed how a low-volatility portfolio produces superior profit.
Investment Executive (IE) featured a list of 40 stocks with the best price stability in Canada in May 2008, as of yearend 2007. IE now is revisiting this subject with a new list as of yearend 2012. (See accompanying table.)
These 40 stocks emerge from a universe of 212 – and almost all are dividend-payers. The calculations follow the method Bernhard used, which requires just simple arithmetic. The lower the score, the more stable the stock.
To be considered, a stock must have been traded for at least 11 years. This eliminates many popular issues. Beta, the basis for new volatility measurements, is linked to a stock index and usually covers only a year or two of trading. Bernhard’s metric is long-term and has no link to a stock index.
Comparing today’s low-volatility stocks with those of 2008, three things are clear: a stable stock usually stays that way; market volatility has increased from the first period measured (11 years ended 2007) to today’s (11 years ended 2012); and the most stable stocks, as a group, beat the market.
The current top 40 stocks include 22 from the 2008 survey – and others from the 2007 group narrowly missed the cut this time. A high-quality stock tends to remain a high-quality stock.
Increased market volatility shows up this way: of the 40 stocks in the 2008 list, all but seven had higher stability scores this time. One of the seven exceptions is no longer traded.
In 2008, the S&P/TSX composite index had a volatility score of 0.188, vs 0.210 for the latest period. The S&P/TSX total return index showed a similar pattern: a score of 0.173 then; 0.203 now.
As for performance, an exact comparison isn’t possible with the S&P/TSX total return index because its dividends are theoretically reinvested immediately. This index rose by 4.1% in the five years ended 2012. Of the 40 stocks in the table at right, 32 beat that gain in total return, and most beat the index handily. Only six of the 40 stocks lost over the past five years.
In the short run, the pattern holds for two S&P/TSX volatility-measuring indices introduced in April 2012. Between then and the end of March 2013, the S&P/TSX composite high beta index lost 23.7%, while the S&P/TSX composite low-volatility index gained by 9.5%. The low-volatility index beat both the composite (up by 5.9%) and the S&P/TSX dividend-reinvested composite index (up by 9.1%).
As is usual with a market fad, low-volatility portfolio investing now may run into a bad spell. As a market observer said years ago: “Wall Street can take a good idea and beat it to death.” The Street did that with quantitative analysis, low price/sales ratios and fast-growth dividend stocks, for example.
All those are good things and now are used in investment analysis and portfolio selection – but none became the last word.
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