INVESTMENT

Low- or High-Instability: Which Won the Return War?


When it comes to instability, there are two considerations of money: the classical view adds more risk to greater rewards. The more risk a portfolio takes, the more potential returns it can achieve in the long run. The more modern approach takes the opposite view: the lower the risk (or instability) of security or portfolio, the higher the expected expectation.

This second approach, often referred to as the “low-volatility abnormality”, has led to the introduction of hundreds of exchange-traded funds (ETFs) and mutual funds over the past ten years that design an equity portfolio aimed at reducing volatility.

So which one is it? Are low-volatility or high-volatility strategies a better choice when it comes to equity returns?

To answer this question, we have used Morningstar Direct data to examine the returns of all low and high-volatility equity mutual funds and ETFs over the past decade. First, we collected performance data from all US dollar-denominated equity mutual funds and ETFs aimed at reducing volatility or investing in high-volatility stocks. These low-volatility funds are often referred to as “low beta” or “minimum volatility”, while parts of their high-volatility are called “high beta”.

We then analyzed how these funds relate to each other on a post-tax basis in the United States, internationally, and in emerging markets.

Our results were clear and unequivocal.

The first interesting takeaway: U.S. high-volatility funds have done much better than their low-volatility counterparts. The average high-volatility fund has earned 15.89% annual revenue on a post-tax basis over the past 10 years, compared to just 5.16% of the average low-beta fund over the same period.


Low volume / low beta Annual after tax return (10 years) Annual post-tax return (five years) Instability
Us 5.16% 7.83% 11.93%
International / Global 2.51% 4.68% 12.58%
Emerging markets 0.11% 0.56% 15.02%
High volume / high beta Annual after tax return (10 years) Annual post-tax return (five years) Instability
Us 15.89% 14.33% 21.49%
International / Global 5.81% 6.21% 17.39%
Emerging markets 4.55% 8.04% 19.54%

When we expanded our tests outside the United States, we found similar results. Funds focused on low-volatile international stocks accounted for 2.51% of post-tax annual returns over the past 10 years, compared to 5.81% of high-volatile funds over the same period.

The remarkable performance of risky stocks in emerging markets was even more evident, with high-beta funds surpassing low-beta funds from 4.55% to 0.11% over the past decade.

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In fact, most low-volatility funds do not even match a broad market index. The average S&P 500 Focused Mutual Fund or ETF has disbursed 11.72% and 10.67% on an annual basis over the last five and ten years, respectively, which is more than a class as a low-volatile fund.

As everyone has said, whatever the low-volatility imbalance, high-volatility mutual funds and ETFs have made significant gains over the last 10 years. This trend will continue for the next 10 years or will be a major development to see if there was an inconsistency in itself.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Image Credit: © Getty Images / IncrediVFX


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Derek Horstmeyer

Derek Horstmeyer is a professor at George Mason University School of Business, an expert on exchange-traded funds (ETFs) and mutual fund performance. He currently serves as the new director of financial planning and asset management at George Mason and established the first student-led investment fund at GMU.

Anna K. Garcia

Anna K. Garcia is a senior at George Mason University, a finance major. He is expected to graduate in August 2021 and is currently vice president of the Montano Student Investment Fund, an investment committee. He works in the banking industry, and by the time he graduates, plans to pursue a position as a personal equity associate or financial analyst. Some of his career interests include investment banking, real estate investing and personal equity.



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