High Returns from Low Risk: A Remarkable Stock Market Paradox

Pim van Vliet runs one of the oldest and most successful Low Volatility funds in the world, which has now flowered into Robeco’s Conservative Equities brand of funds. It is noteworthy that it is not referred to as “low volatility,” because when he began this strategy in 2006, low volatility was not a ‘thing.’ High Returns from Low Risk is targeted at airport readers and casual investors, and is a quick read that makes a profound point: objectively, high volatility stocks are bad investments.

While students are taught that expected returns are an increasing linear function of risk, within most asset classes, highly risky assets generate consistently lower returns than do those with average risk, and, after transactions costs are included, risky asset classes, such as options, are horrible investments for individual investors, the more so the riskier the option. Risky assets attract excessive interest from investors, and academics help them rationalize this adverse preference through their extensions of the Capital Asset Pricing Model (CAPM), all of which are very rigorous, but wrong. The “low vol” anomaly is not restricted to developed country equities. He has found it in emerging markets, and within equity industry sectors. He notes it has been found in corporate bonds, equity options, movies and private equities, but he could have added penny stocks, IPOs, real estate, currencies, futures, and sports books.

Pim recounts his discovery and implementation of the low volatility edge. In one anecdote, he credits his colleague David Blitz for noting that relative rather than absolute performance affects investment manager: underperforming is a greater threat to a long-only portfolio manager than is losing money. That is, if you lose 10% in a market that is down 10%, you did average, and your assets under management will probably not be decreasing. However, if you make only 5% in a market up 15%, assets will go down. Risk is symmetrical: it can be too great or too little, because if you take too little risk, you will underperform in bull markets, which is just as bad as those who take too much risk and underperform in bear markets.

This discovery implied it would not be an easy sell to tell investors that his low-vol tilt generates better returns merely because they have lower volatility, because they would have higher relative volatility. Yet this could be precisely why the strategy presents an opportunity, in that, for a portfolio manager, ‘low risk’ is actually ‘average risk,’ so risk averse professionals do not invest in low, but rather in average beta stocks (aka, closet indexing).

He presents a “law of three”—omne trium perfectum—all good things come in threes. In this context, the law of three is low vol, momentum, and value. His value metric is a form of price-to-income ratio, such as dividend yield or P/E. I am skeptical of a law stating 3 is the cardinality of attributes for Platonic forms, but agree that, in this case, it is a handful and not a factor zoo of dozens.

His portfolio formulation is refreshingly clear. First, normalize momentum and value using percentiles, sum them, apply to the “low vol” half of stocks, and viola, you have a darned good portfolio. Investors would be wise to follow simple rules for investing. Those with the humility that comes from wisdom will be relieved to know that they can optimize their investments by merely focusing on lower-than-average risk stocks that make money, generate dividends, and have performed well. Those who need the advice most—average equity investors—are least likely to take it.

This is a great book. It deserves to read by both serious investment professionals and DIY investors. The focus on low volatility investments was an eye opener for me and income and momentum factors resonated with me. The authors have managed to write a book that is easily read and entertaining as well as providing cutting edge research findings. It also ticks the box for a blend of author academic and practitioner background. I read it in 24 hours which is a first for me – I couldn’t put it down. There are actionable ideas that can be implemented at no cost. There is also a great underlying philosophy to investing and life that readers can benefit from.

Well researched and well written. Deep down inside, we all know the tortoise wins the race. But we really want to be a rabbit, enjoying speed and excitement. My question, and the authors’ question, do want to enjoy excitement or higher returns?
Buy this book, read it and implement a low risk strategy for your portfolio.

Very concise, helpful and straight to the point.

This is an insightful book providing a great introduction into the world of low-risk investing. Highly recommended for both beginners and professionals.

Paradox is the keyword here, being a contrarian has benefits and I think this book is trying to get this message across.

An absolute gem. It’s refreshing to see a unique and original book on investing. So many books say the same thing in a different way. This book is different and I highly recommend. This would also be a good gift idea.

Expected details and data on absolute and relative stock price volatility. Little of that. Author is earnest.