Inspiring Market Efficiency Results…NOT!

Inspiring Market Efficiency Results…NOT!

August 20, 2014 Research Insights
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(Last Updated On: September 23, 2014)

Yes, it is true, lower risk securities have historically outperformed higher risk securities. We’ve seen this in a variety of academic research pieces, but sometimes you gotta grind the data on your own to really understand and get comfortable with the results. A recent paper and this paper and some of our own internal research has suggested that the “low vol” anomaly might be bunk. We are on a data adventure to get to the bottom of this anomaly…

Legend:

  • Col 1 = high idiosyncratic stocks, monthly rebalanced, equal-weight, mid/large cap only, 1927 to 2013
  • Col 2 = high beta stocks, monthly rebalanced, equal-weight, mid/large cap only, 1927 to 2013
  • Col 3 = low idiosyncratic stocks, monthly rebalanced, equal-weight, mid/large cap only, 1927 to 2013
  • Col 4 = low beta stocks, monthly rebalanced, equal-weight, mid/large cap only, 1927 to 2013

The chart below is part of a larger study we’ll be sharing in the near future (click to enlarge):

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.
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.

In the meantime, gleam over the numbers.

There is definitely a counter-intuitive relationship between risk and return. Higher risk, lower return; lower risk, higher return.

The difference between IVOL and BETA are trivial and highly correlated (90%+).

But are these spreads robust? Are they other anomalies in drag? We are going to find out…

 


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Steve

    As per previous posts, Wes I think you have got something against the anomaly! Just kidding.

    My understanding is that you will find volatility to overlap but not be completely subsumed by value.

    Low vol is one of Asness’ “true” 4 factors (value, momentum, volatility/beta and yield…which is a value play in equities). Interestingly Asness, despite doing work in the Gross Profits to Assets ‘quality’ thing does *not* (at least not at this point) count it as one of “the” factors.

    Other research has shown that you are better off not paying too much for the low vol portfolio – but that makes sense…everything I’ve been reading (especially recently) seems to show that blending anything together (whether compositing within a factor, like value or blending the various factors together) works better. So it makes sense that not paying too much for low vol works better.
    And, for that matter…’adjusting’ momentum via volatility ‘works’ as well.

    But keep going Wes…I want to see that I can forget about volatility preferably! I find value and momentum enough factors for me personally, but I feel guilty not including quality and volatility! I’m happy to ignore size and liquidity though. Looking forward to further posts on this Wes!