As factor investing goes, low-volatility investing gets an increasing amount of attention. Unlike the value factor, its performance hasn’t been recently called into question, and unlike momentum, turnover can be relatively low. However, it’s curiously unintuitive, as it suggests that lowering your risk can actually increase your return.
One robust way to test out factors is to see if they hold up across geographies. Researchers have found that low volatility does appear to work in China for the A Shares Market, though in a slightly different manner to the U.S. market. This is also relatively recent research looking at the 2000-2018 period, so may be less prone to the issue that historical performance can decline once the factor is well understood. This research is titled ‘The Volatility Effect in China’ and produced by researchers at Robeco Investments.
The Results
The results are relatively striking. A low volatility strategy in China can return an additional 3%-6% per year, broadly speaking, depending on the implementation approach. That’s ahead of what many factors can be expected to deliver in the U.S. market and may be a function of China’s more retail-investor heavy market structure. Also, volatility appears to be the most effective metric for this factor in China, whereas in the U.S. other formulations are typically more successful.
Lottery Tickets
One reason why low-volatility investing may perform better than expected could be to do with the lottery-ticket effect. Basically when investing, it’s very tempting to want to make money quickly. High risk stocks apparently offer this prospect, and so, may be enticing to investors.
However, of course, if everyone wants to make risky bets for large potential gains then the returns to that category of stocks will be reduced as the price is bid up. That may be exactly what is happening in China, especially due to the high proportion of retail investors in the Chinese market.
Other Factors
Low volatility does appear to be a strong factor in the Chinese market, if recent history is any guide. It performs best of the major factors on a risk-adjusted basis, though value also tends to perform well in China, as does size to a lesser extent. It’s notable that despite the debate about the value factor in the U.S., value is clearly not dead in China. Other factors do less well over the 2000-2018 period. As these factors become better understood in a Chinese context it will be interesting to see if their returns fade as may have occurred in the U.S. or if they will remain active as long as Chinese trading is dominated by retail investors.
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January 23, 2021 at 08:27AM
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Low Volatility Investing Works In China Too - Forbes
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