Low volatility US stocks have beat the broader benchmark during six of the largest market crashes since 1972, according to a recent S&P Dow Jones study, outperforming by almost 50 per cent in one period.
The analysis, published this January, found that a low volatility version of the S&P 500 index recorded better peak-to-trough returns than the US equities benchmark through market downturns ranging from the 1970s oil crisis to the brief tumble in the final quarter of 2018.
Crash market outperformance also enabled the low volatility index to return to par well ahead of the full-blown index, the report says, in all six examples.
“… if the low volatility index loses less than then benchmark during drawdown periods, it does not have as much to recoup in recovery,” the study says.
For instance, the so-called ‘Black Monday’ 1987 crash saw the main S&P 500 index drop 32.5 per cent from peak-to-trough over a three-month stretch.
“During the downturn period, the low volatility index declined by 26.8% and recovered a full 50 trading days prior to the S&P 500,” the paper says. “By the time the benchmark recovered fully on May 15, 1989, the low volatility index had outperformed by 8.2%.”
In the 2008 global financial crisis (GFC), the S&P 500 fell more than 55 per cent from high to low, or a more than 15 per cent worse result than the low volatility index.
However, the low volatility index recorded its highest outperformance figures during the early 2000s ‘tech wreck’, returning a positive 2.4 per cent over the two-year slump against a whopping loss of almost 50 per cent for the full benchmark.
Aside from their crash-cushioning qualities, the S&P study says low volatility stocks also capture most of the market upsides – with some caveats.
“… low volatility indices typically outperform when the reward for outperformance is greater and usually underperform when the associated punishment is relatively subdued,” the report says.
Elsewhere, the report dismisses claims that low volatility is a simple ‘rates play’, benefitting from “a multi-decade, perhaps once-in-a-lifetime, downward trend in bond yields”.
“For example, the low volatility index typically underperformed by an average of 1.24% (full history) when the market and rates both rose,” the S&P analysis says. “Furthermore, the low volatility index typically outperformed when rates rose and the market fell. Conversely, when rates declined, the low volatility index typically trailed the S&P 500 when the market rose, and it outperformed when the market declined.”
The study used new datasets dating back to 1972 to extend earlier low volatility research based on figures starting in the early 1990s.
S&P says the “research shows that the ‘low volatility anomaly’ is universal: this observation applies over multiple time horizons, geographies, and market segments”.
The latest report was authored by a panel of S&P analysts including senior director global research and design, Phillip Brzenk, and director strategy and volatility indexes, Tianyin Cheng.