Npec Essay

4675 Words Jan 3rd, 2016 19 Pages
T H E

J O U R N A L

THEORY & PRACTICE FOR FUND MANAGERS

O F

FALL 2013 Volume 22 Number 3

RISKBASED
PORTFOLIOS

special section

The Voices of Influence | iijournals.com

Pursuing the Low Volatility
Equity Anomaly: Strategic
Allocation or Active Decision?
ERIK KNUTZEN

ERIK K NUTZEN is the chief investment officer at NEPC LLC in
Cambridge, MA. eknutzen@nepc.com FALL 2013

JOI-KNUTZEN.indd 75

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n the past several years, asset managers have built investment strategies based on historical evidence that lower volatility stocks earn superior risk-adjusted returns. These approaches are being called low volatility, managed volatility, minimum variance, or similar names. They seek to exploit what has
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Furthermore, given the strong performance of low volatility stocks over recent time periods, now may be an inopportune time to make such an allocation to this new category.
LOW VOLATILITY STOCKS:
PERFORMANCE

According to capital market theory, as investors move away from risk-free assets they expect to be compensated with higher returns in the long term. This relationship between risk and return is described by an upward sloping capital market line (Exhibit 1).
For a diversif ied equity portfolio, capital market theory indicates a relationship between the portfolio’s sensitivity to the broad market benchmark and expected return. This sensitivity is quantified in the beta of the portfolio. A broad market benchmark, such as the S&P 500, which represents large-company U.S. stocks, has a beta of
1.00. A diversified portfolio constructed of aggressive growth stocks might have a beta of 1.20, while a similarly well-diversified

THE JOURNAL OF INVESTING

8/20/13 3:28:43 PM

EXHIBIT 1
Theoretical Capital Market Line

Source: NEPC, LLC.

portfolio of more conservative stocks might have a beta of 0.80. While beta and volatility are not equivalent, they measure similar risk relationships. In general, it is expected that lower-beta stocks will exhibit lower volatility than the benchmark and, conversely, a portfolio of higher-volatility stocks will exhibit higher beta than the benchmark.
That said,

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