A recurring question I have heard about low volatility investing is, “Where’s the pain?” In other words, how can an investment strategy do so well if it requires little in the way of commitment during rough periods? Simply put, to many, the idea that a strategy can outperform over long periods while stomaching less volatility and shallower drawdowns along way simply sounds too good to be true.
Yet it would be a mistake to think there is no pain associated with low volatility investing; there is. It is simply not the pain that most investors envision. As low-volatility expert Pim van Vliet said in a recent podcast, the pain of low volatility investing is unique among investment strategies as it requires discipline to tolerate the boredom associated with it. Instead of wild swings up or down, or prolonged periods of excess then inferior performance, low volatility investing can be grueling for impatient investors; though the benefits of the strategy should compound over time, the lack of excitement along the way can be torturous for impatient investors who see friends and family enjoying (for a time, at least) the ride of faster-paced strategies.
Take, for example, the fact that since January of 1994, the S&P 500 Low Volatility Index has averaged market-beating returns (10.88% through April versus 9.68% for the S&P 500), despite underperforming the S&P 500 in fifteen out of twenty-six years (including so far in 2019):
By comparison, the S&P 500 Growth Index, which has also outperformed the overall market (10.27% per year through April), has done so in a more conventional way, outperforming the market in sixteen out of twenty-six years:
Over rolling periods, the differences are a bit starker; while the Low Volatility index has suffered numerous three-year periods of lagging performance, the Growth index has rarely lagged outside of the tech bubble bust:
Yet perhaps the best way to illustrate Pim’s point about the the relative boredom associated with low volatility investing is to plot monthly returns next to the index’s and Growth’s:
Clearly, relative to the index and the competing style, Growth, Low Volatility’s monthly returns are somewhat muted, falling in a tight range. It is precisely this “tortoise versus the hare” approach that constitutes the “pain” of low volatility investing, and perhaps explains why it has been a durable strategy over time. As Pim put it so well, “Only in hindsight will you see the benefits of low vol investing.”