It flies in the face of traditional financial theory. Still, study after study suggests that avoiding risky stocks can often improve your risk-adjusted investment returns.
Recently, researchers at the Stern School Of Business and AQR Capital Management have reviewed the evidence. They find that lower risk stocks tend to come out ahead on a risk-adjusted basis.
What Low-Risk Investing Means
There are numerous strategies under the umbrella of low-risk investing. You can buy stocks that have tend to be less volatile, or move less with the overall markets. You can also invest in more stable stocks with more stable earnings or fatter margins and healthier balance sheets. However, regardless of the measure chosen, the researchers find that higher quality stocks tend to outperform over time on a risk-adjusted basis.
Return Without The Risk
In a sense, this is a puzzle compared to traditional financial theory. Generally, if you are taking on greater risk with your money, you would expected a higher expected return. Though, that’s not the pattern the data shows.
Breaking The Rules
Historic data suggest that markets aren’t necessarily following the rules, or at least not enough compensation is provided for the level risk. Essentially, taking on risk may get you a slightly higher return, but the extra return generally isn’t worth it for the risk involved.
Imagine an upward sloping line, giving you more return as you ratchet up your investing risk. The reality isn’t that simple. In fact, that line appears to be fairly flat. As you increase your risk, yes, your returns become more volatile and less predictable, but they don’t increase your returns as much as you would expect. You aren’t necessarily getting rewarded for the sleepless nights that a risky portfolio might entail. Dialing back your portfolio risk may actually be a free lunch.
Not Foolproof
Needless to say, the strategy is not without risk. Even though returns have historically been robust for lower risk strategies, there have been periods of clear drawdowns such as 1931-32, 1998-1999 and 2008-2009. The study ended prior to the spring 2020 market decline, so there’s no analysis of that period. So it’s no silver bullet, but can be a way to finesse your portfolio.
Implementation
The message then is that risk is generally best avoided. The market does not reward you for it as you might expect. Yes, you can still enjoy superior returns buy owning stocks, but you don’t necessarily need to own risky stocks to achieve the best returns.
How It Stacks Up
Also, this isn’t just an oddball theory. It holds up against some of the more traditional factors that investors more commonly focus on. For example, focusing on lower risk investing has returns that aren’t too different from a strategy like value investing running data back to the 1930s. In fact, there’s only one factor that’s noticeably ahead of the low-risk strategy, and that’s momentum, which means owning stocks with better short-term price performance.
Annual Returns
Implementation of a lower risk strategy, depending on the method used, has historical delivered additional returns of around 2% to 10% a year, on average, based on history. That’s top of the underlying returns to stock investing that we’ve seen historically. As such low risk investing has the potentially to enhance long-term returns considerably if history is any guide.
Of course, with any factor-based strategy there’s no guarantee that the future follows the pattern of the past. Still, the evidence is quite compelling that saddling your portfolio with additional risk, isn’t necessarily a way to boost your investment returns.
Playing it safe, may both help the risk and return of your portfolio. That’s not what financial theory might suggest, but it is what historic data shows.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
