Does low volatility strategy really pay?
The present time is not the best time to ask investors how much risk they can handle. People are more aggressive when the markets are doing well but when it turns downside, people tend to adopt a conservative approach.
We do have India VIX, which is a volatility index that measures the market’s expected volatility in the near term. The meaning of volatility is often assumed to be rate and magnitude of changes in prices. In short, it is viewed as a risk indicator. Currently, India VIX stands at 55.30 that were 24.23 a month back. This indicates that in just a matter of one month, the volatility increased by whopping 128 per cent. Therefore, it can be said that currently, markets are trading in high risk zone.
Besides, low volatility is one such investment strategy that is said to perform during tough times. So, is it relevant? We will find it out in the coming paragraphs.
What is low volatility strategy?
Low volatility is a factor-based investment strategy that typically invests in stocks having a low volatility. Standard deviation is the parameter used to understand the volatility of stocks. Lower the standard deviation, lower is the volatility of that particular stock.
To understand its performance, we have compared S&P BSE low volatility index with S&P BSE 200 Index. Now, you must be wondering why we are comparing it with S&P BSE 200. The reason for the same is that, S&P BSE low volatility index is derived from S&P BSE 200.
* Index values are re-based to 100.
As you can see in the above graph, the volatility increased in the month of March 2020, S&P BSE low volatility index started to fall less, as compared to S&P BSE 200 index. The year till date (YTD) returns i.e. from January 1, 2020 to April 3, 2020 of S&P BSE low volatility index stood at negative 18.79 per cent. The returns of S&P BSE 200 for the same period, was negative 32.41 per cent. Thus, S&P BSE low volatility index outperformed by a whopping 13.62 per cent. Hence, we can say that the low volatility strategy does work in crises. However, such a strategy won’t prove fruitful when the market jumps.