Big Risks Aren’t Necessary To Get Good Returns

How Has Low Vol Done in 2015?
This year the evidence is mixed. Sometimes low volatility indexes have beaten the standard index. Sometimes they haven’t.

But Lazzara says that’s not surprising. Despite some rough times, the S&P hasn’t been down that much this year. “The test of low vol investing is in the really bad years. For instance in 2008, when the S&P was down 37%, the low vol index was only down 22%.”

He adds that “low vol investing will smooth out returns. It attenuates them. You will not go down and up as much.”

Still, John Rekenthaler, another Morningstar analyst, cautions that there are still questions about low vol. In a recent commentary, he argued that standard deviation is only one way to measure risk. Another way is to use tail risk. That looks at how a fund performs in extreme conditions.

The means investors should also use another metric, called “excess conditional value-at-risk,” or “ECVaR,” which evaluates how a fund behaves during sharp downturns. This measures whether a fund suffers particularly bad results when stocks are plummeting, he argues.

“If ECVaR is used to calculate risk rather than standard deviation, mutual fund results line up according to standard investment theory,” Rekenthaler writes in a commentary. “That is, the lowest-risk funds as measured by ECVaR have the weakest future returns, and the highest-risk funds have the best. This holds true for both U.S. and foreign equities.”

Who should one believe and how should an advisor cope with a force of nature called volatility that can’t be avoided by anyone fully invested over long periods?

Maybe the best answer is no answer. Investors should just stay fully invested through good times and bad. That’s an option one might have well considered during the height of the volatile market this year.

“What to do during market volatility? Perhaps nothing,” advised Bill McNabb, chairman and CEO of Vanguard Funds in a recent advisory. “Often the wisest thing to do during periods of extreme market volatility is to stick with an investment plan.”