Low volatility factor
TheoryDefinition
The anomaly that low-volatility stocks earn equal or higher returns than high-volatility stocks, with dramatically lower risk. This directly contradicts CAPM, which predicts that more risk equals more return.
Historical premium: positive risk-adjusted alpha of ~2–3% per year; sometimes higher absolute returns than the market in high-vol regimes. Mechanism: retail investors chase “lottery” stocks (high volatility, skewed payoffs) and overpay for them, leaving boring low-vol stocks mispriced cheap.
Works best in crashes and drawdowns. The classic defensive factor — think Warren Buffett’s “cigar butt” phase: boring, unloved, profitable.
Historical premium: positive risk-adjusted alpha of ~2–3% per year; sometimes higher absolute returns than the market in high-vol regimes. Mechanism: retail investors chase “lottery” stocks (high volatility, skewed payoffs) and overpay for them, leaving boring low-vol stocks mispriced cheap.
Works best in crashes and drawdowns. The classic defensive factor — think Warren Buffett’s “cigar butt” phase: boring, unloved, profitable.
Example
USMV (iShares MSCI USA Min Vol Factor) selects low-volatility US stocks with sector constraints. 2022: USMV was down only 10% while the S&P 500 was down 18%. 2013–2023 CAGR ~10% with 30% lower volatility.
Related tool
Open the backtester tool on Arsenal.finance →