Christine Benz: Hi, I am Christine Benz for Morningstar.com. In the wake of strong performance from low-volatility stocks over the past decade, investors are increasingly looking at low volatility as a strategy. Joining me to discuss this phenomenon is Shannon Zimmerman. He is associate director of fund analysis for Morningstar. Shannon, thank you so much for being here.
Shannon Zimmerman: Good to be with you, Christine.
Benz: Shannon, let’s start by talking about what defines a low-volatility stock. What characteristics specifically are people looking at?
Zimmerman: Well, with the panel that I moderated at the Morningstar ETF Conference, I had Raman Subramanian from MSCI, Craig Lazzara from S&P, and Jeremy Schwartz from WisdomTree. WisdomTree doesn’t actually have a low-volatility strategy. We will talk about them when we get to the dividend portion of this segment.
But MSCI and S&P have very different methodologies. And so, you look at industrywide approaches to navigating this space, and people look at standard deviation sometimes over a certain period of time--a one-, two-, or three-year period. Or beta, and using beta as a marker for volatility and then going lower than the market to get your low-volatility exposure, that’s the more academically vetted approach to low volatility, which over time has really shown to deliver quite a premium for investors who can stick with it over the long haul.
Benz: You ran a study a couple of months ago where you looked low-volatility stocks over the past decade. Is there a data that stretches back even further that looks at the performance of the stocks during a broader variety of market environment?
Zimmerman: Sure. There is. In fact, the paper that looks at the longest time series focused on this low-volatility premium, it really is an anomaly. People think higher risk, higher returns, but this paper argued no. And it showed pretty conclusively that wasn't the case. It looked at the time series of 40 years.
You have to be patient; there are going to be periods for any strategy or any approach that you will experience underperformance. You have to always qualify, this is back-tested, looking at results in the rearview mirror. But for investors who were patient over that stretch of time, they did have a significant amount of outperformance relative to people who were just invested in the broader market.
Benz: One focus of the recent panel at the Morningstar ETF Conference was to compare low-volatility strategies with high-dividend-yield strategies. Both are very popular right now, high dividend yield, maybe especially. But what did the panelists find, when they compared and contrasted the two strategies?
Zimmerman: Well, there are couple of things that came out of the discussion. I thought it was a really good discussion on this point, because folks were quite candid in saying there is a high level of correlation between the two strategies. And there is a way in which, the work that we do kind of leads you to become skeptical about marketing of investment products, and it's interesting to me that the strategies are sort of pitched differently. "Here's our low-volatility approach; here is our high-dividend approach." When really there is a high degree of correlation between those approaches. They would land in the large-value categories typically, and the folks who are on the panel acknowledge that.
Now, we had a representative from WisdomTree as well, and the firm doesn't have a low-volatility strategy. It is focused primarily on dividends, and he did point out that even though there is that level of correlation, the performance patterns between the strategies are different enough that people can kind of smooth the performance of their overall portfolio by having exposure to both.
Benz: Shannon, when you examine the commonalities among high-dividend payers and low-volatility stocks, why is there that overlap? Is it because high-quality companies tend to pay dividends and tend to hold up better during market downturns? Is it as simple as that?
Zimmerman: I think that’s one aspect of it. If a company pays a dividend, that’s typically, though not always, a sign of financial health. So yes, the financially healthier companies tend to be the lower-volatility companies, as well. So there is a tight correlation there. There is not a tight correlation though in terms of how these products are being marketed. They are stand-alone, separate strategies, that of course [the companies say] investors need exposure to, and that’s always a good question worth asking, too. Do you already have this exposure?
On the other hand, as skeptical as I tend to be about some approaches to marketing mutual fund products, or any fund products at all, it’s hard to be too cranky when the trend is toward lower-volatility, higher-quality funds.
Benz: A lot of data here are then pointing to the outperformance perhaps over time of high-quality, dividend-paying stocks?
Zimmerman: That’s what the evidence shows. If you are patient, you’ll outperform.
Benz: Thank you so much, Shannon. Thanks for sharing your insights.
Zimmerman: Good to be with you.
Benz: Thanks for watching I am Christine Benz from Morningstar.com.