Low Short Interest Dominates Low Vol Strategies

////Low Short Interest Dominates Low Vol Strategies

Low Short Interest Dominates Low Vol Strategies

By | 2017-01-18T12:11:40+00:00 June 11th, 2014|Research Insights, Low Volatility Investing|8 Comments
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(Last Updated On: January 18, 2017)

The Long and Short of the Vol Anomaly

Abstract:

On average, stocks with high prior-period volatility underperform those with low prior-period volatility, but that comparison is misleading. As we show, high volatility is an indicator of both positive and negative future abnormal performance. Among high volatility stocks, those with low short interest actually experience extraordinary positive returns, while those with high short interest experience equally extraordinary negative returns. The fact that publicly available information on aggregate short selling can be used to predict positive and negative abnormal returns of great magnitude points to a large-scale market inefficiency. Further, based on the evidence in this study, the current “low vol” investing fad has little or no real foundation.

Alpha Highlight:

The authors remind everyone of the new “fad” in investing: low volatility investing. As other papers show, low volatility investing has outperformed in the past:

low vol 1

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

 

However, investors should proceed with caution.

Combining another common measure–short interest for a stock–with volatility produces some intriguing results.

The chart below shows that the best performing portfolio goes long firms with HIGH volatility and low short interest!!!

low vol 2

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

 

Two explanations from the authors to describe these returns:

  1. Omitted systematic risk factor, or…
  2. Misvaluation exists and short sellers are good at identifying potential problems on the horizon.

Overall, whenever one variable (short interest) can ruin a strategy (low volatility), it highlights a robustness issue.

Here are some ETFs focused on low/min volatility if you’re interested in who is datamining.

Time to go buy a low volatility ETF?


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About the Author:

Jack Vogel, Ph.D., conducts research in empirical asset pricing and behavioral finance, and is a co-author of DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His dissertation investigates how behavioral biases affect the value anomaly. His academic background includes experience as an instructor and research assistant at Drexel University in both the Finance and Mathematics departments, as well as a Finance instructor at Villanova University. Dr. Vogel is currently a Managing Member of Alpha Architect, LLC, an SEC-Registered Investment Advisor, where he heads the research department and serves as the Chief Financial Officer. He has a PhD in Finance and a MS in Mathematics from Drexel University, and graduated summa cum laude with a BS in Mathematics and Education from The University of Scranton.
  • Michael Milburn

    As I was reading about short interest (and being generally unfamiliar w/ the range of stats for the measure), I had a tough time figuring out what levels of short interest were considered “high” or “low”, so for future readers I just wanted to point them to Table 4 on page 34 of the paper for summary info on “high” and “low” stats regarding short interest on high volatility stocks that might be useful for hobbyists. The avg and median level of days to cover for the high volatility stocks in the study is 5.57 and 3.55 respectively. The “high” short interest group has avg and median levls of days to cover of 13.17 and 11.19 respectively. “Low” short interest levels were avg/median dtc of 0.82 and 0.46.

    Again – those stats were just for high volatility stocks – not the universe as a whole, but gives a feel for what levels are “high” and “low” for that group. (Hi and low volatility stocks are the top or bottom 20% of stocks by ranking)

  • dph

    Maybe low volatility might be a worthwhile strategy in markets where there are short selling (and option contracts) constraints or maybe these constraints existed in the past and skew the results?

    Also is there any ETFs that screen for high volatility with minimal short interest; do you suspect that’s an anomaly that has lasting potential?

  • Honestly, there aren’t many ETFs that actually use strategies with an empirical basis. They tend to be “glossy” products that can sell, but when you dissect them they are not actually doing much beyond closet-indexing.

  • dph

    I hope to see you guys review some of the “smart” etfs. Most seem to be expensive tilts on indexing, which is fine if they were marketed as such.

  • Jack Vogel, PhD

    We agree, and have an article on how expensive smart beta ETFs can be, located here: http://ec2-54-197-197-10.compute-1.amazonaws.com/2014/10/21/why-smart-beta-is-more-expensive-than-you-think/

  • dph

    Outside of you guys and Meb who else has some “smart” products; I’m trying to avoid high correlation to the S&P?

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