Tahoe-Truckee Market Beat: The fluctuations of stock market volatility
Special to the Sun
In the past I have written about volatility cycles in the stock market. On average, the market spends about 85 percent of the time steadily rising with low volatility; the other 15 percent of the time the market is in a phase of higher volatility and falling prices.
Recently someone asked me if there was a way to put together a stock portfolio that had relatively low volatility. The answer is yes — there are some ways to build low volatility stock portfolios for people who get stressed out by periods of high market volatility.
Standard & Poor’s is the company that oversees the S&P 500 index. They have many other indexes in addition to the S&P 500. One index they have designed is known as the S&P 500 low volatility index.
The way the low volatility index is put together is pretty simple — Standard & Poor’s analyzes the 500 stocks that comprise the S&P 500 and selects the 100 stocks with the lowest historical volatility over the last year.
Those 100 stocks make up the low volatility index, and every year it is rebalanced, so only the stocks with the lowest standard deviation stay in it.
The performance is interesting. As of March 31, 2015, the 100 low volatility stocks had outperformed the S&P 500 over one-, five- and 10- year periods.
Over the last 10 years, the low volatility stocks returned an average of 9.36 percent vs. 8.01 percent for the S&P 500. For the five-year period, they beat by 15.24 percent vs. 14.47 percent, and over the last year, by 14.58 percent compared to 12.73 percent.
The S&P 500 consists of large cap US stocks, so that low volatility index only contains large cap US equities.
Further diversification could be obtained by broadening the universe so that the low volatility issues are chosen from a broader base to include small caps, mid caps and foreign issues.
Using strategies like this involves rebalancing on a regular basis. Just because one stock has had low volatility performance in the past is no guarantee that it will perform that way in the future.
Stocks that were previously quiet performers can fall out of favor and become volatile.
When the re-balancing is done, stocks that have shown an increase in volatility are sold and replaced with ones that have exhibited low volatility in the past year.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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