Investors who have followed my reports over the years, would know that I like to use well-known sayings to either point out or describe a variety of terms or market movements. But there is one saying that regularly makes its appearance in the investment world: “High risk, high reward.” Without wanting to offend thrill seekers, right of the bat I have to make it clear that I DO NOT associate myself with this saying. In fact, I disregard it completely.
For those of you who are not so familiar with these styles, Quality shares are valued based on strong returns on equity (ROE) and the lowest possible enterprise value (EV) -to-free-cashflow ratio. Momentum on the other hand, focuses only on share prices that rise sharply, while avoiding or selling shares that decline in value.There are a few instances in which this saying can actually be proved wrong. One such area is when you take a closer look at different investment styles. We are all familiar with the most popular three styles, namely quality shares, momentum shares and value shares.
Value investing is more focused on shares that have a higher earnings yield, a lower price-to-book ratio and a lower EV to earnings before interest, taxes, depreciation, amortisation (EBITDA) and enterprise value-to-EBITDA ratio (EV/EBITDA).
There is another style or factor, however, that can be added to this list, called low volatility shares. As the name indicates, this type of investing focuses on shares with the lowest possible volatility relative to their peers.
Let’s have a look at one of the most well-known examples of low or minimum volatility benchmarks, the MSCI All Country World Minimum Volatility Index (ACWV). This index aims to track the investment results of an index that consists of both developed and emerging market shares that collectively have lower volatility characteristics compared to the broader spectrum of developed and emerging equity markets. When we compare this index to the MSCI All Country World Index (ACWI), it is interesting to note that the ACWI has a three-year volatility ratio of 11.3%, while the ACWV has a volatility ratio of only 7.6% over the same period.
The volatility ratio can be used quite effectively to determine the risk of a specific investment. When an investment in something like the ACWI has a volatility ratio of 11.3%, it means that this investment had already moved up and down by 11.3% over that three-year period. It also means that the ACWV traded at roughly two thirds of the ACWI’s risk (7.6% vs. 11.3%).
Now let’s apply this to the saying quoted above. If this saying was true, surely you would have expected a much higher “reward”, seeing that you took more than one and a half times the ‘risk’? But the answer is no. Yes, over this three-year period (until 11 November 2019), the ACWI did in fact deliver a wonderful return of 10.02% per year in USD-terms. The ACWV, however, delivered a return of 10.09% over the same period, and outperformed the ACWI by even more over a 5-year period.
When we shift our attention away from international sectors and more towards local sectors, you will see that the picture still looks pretty much the same. By applying the same method to local style-orientated ETFs, you will see that no different to the international trend, Momentum has also been the dominant factor for the last year and a half.
What you will see in the graph above, is that low volatility shares wasn’t only the second-best performing factor locally, but that it also outperformed the FTSE/JSE Top40 Index ETF quite comfortably.
As a final note, I want to make it abundantly clear that historical price movements do not guarantee any
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.