Current Thoughts

On Volatility

On December 14th, global stocks (as measured by the MSCI All Country World Index) dropped another 1.58%. US stocks (as measured by the MSCI USA Index) dropped 1.88%. Clearly, volatility has found its way back into the marketplace in 2018 and we thought we would take a moment to shed some light on exactly what it is everyone means by volatility.

What is "volatility"? The easiest way to think about volatility is the extent to which an asset bounces around in value, typically by greater than 1% in a day. However, there is a general relationship between asset returns and volatility in that they tend to be negatively correlated - as asset prices go up, their volatility tends to go down.

How is volatility measured? While volatility is simply an asset's standard deviation (how dramatically values move; high standard deviation means high volatility and vice versa), investors tend to use the VIX as a barometer. The VIX is the Chicago Board of Options Exchange's (CBOE) Volatility Index and it measures the market's expectation for future volatility. Over the last year, according to CBOE, the volatility index has gone from a low of 8.9 to a high of 50.3 and its current level of 22.4 as of today.

What causes it? In a nutshell, events that cause greater uncertainty about the future cause some assets (particularly stocks) to become more volatile. Recall what happened in 2017 when the UK voted to leave the European Union. Today, there is day-to-day uncertainty about a trade war with China, the Federal Reserve's path to higher interest rates, and the potential for a US (if not global) recession.

What is the factor? There is much academic work (i.e. Ang et al.) that demonstrates low volatility (or minimum variance) stocks tend to provide higher returns than high volatility stocks over time.

What is the record? Over the 15-year period ended November 30, 2018, global minimum volatility stocks** returned 9.24% with a standard deviation of 10.22%. Over the same period, the market (MSCI ACWI) returned 7.14% with a standard deviation of 14.79. So lower volatility stocks have generated a 2.1% higher return with approximately 30% less volatility!

*All return data from Morningstar

**Global Minimum Volatility stocks = MSCI ACWI Minimum Vol (USD) NR USD; this index was launched November 30, 2009. Return data prior to that is back-tested.

Past performance is not an indication of future results.

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Click below to see our one-pagers on the various factors, including low volatility.

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