When it involves volatility, there are two schools of thought within the financial world: The classical view associates higher risk with higher return. The more risk a portfolio takes, the more potential return it may possibly generate over the long run. The more modern perspective takes the other view: the lower the danger (or volatility) of a security or portfolio, the upper the expected return.
This second view, sometimes called the “low volatility anomaly,” has led to the introduction of a whole lot of exchange-traded funds (ETFs) and mutual funds over the past decade that design equity portfolios with the goal of minimizing volatility.
So which is true? Are low volatility strategies or high volatility strategies the more sensible choice in relation to stock returns?
To answer this query, we used Morningstar Direct data to look at the returns of all low- and high-volatility equity funds and ETFs over the past decade. First, we collected performance data from all U.S. dollar-denominated equity funds and ETFs whose objective is to either minimize volatility or put money into high-volatility stocks. These low-volatility funds were sometimes called “low beta” or “minimized volatility,” while their high-volatility counterparts were known as “high beta.”
We then analyzed the relative after-tax performance of those funds within the US, globally and in emerging markets.
Our results were clear and unambiguous.
The first notable finding: US high-volatility funds performed significantly better than their low-volatility counterparts. The average high-volatility fund generated an annualized after-tax return of 15.89% over the past decade, in comparison with just 5.16% for the common low-beta fund over the identical period.
| Low Volume/Low Beta | Annualized return after taxes (10 years) | Annualized return after taxes (five years) | volatility |
| US | 5.16% | 7.83% | 11.93% |
| International/Global | 2.51% | 4.68% | 12.58% |
| Emerging markets | 0.11% | 0.56% | 15.02% |
| High Volume/High Beta | Annualized return after taxes (10 years) | Annualized return after taxes (five years) | volatility |
| US | 15.89% | 14.33% | 21.49% |
| International/Global | 5.81% | 6.21% | 17.39% |
| Emerging markets | 4.55% | 8.04% | 19.54% |
When we expanded our research beyond the U.S., we found similar results. Funds focused on low-volatility international stocks averaged 2.51% annual after-tax returns over the past decade, while high-volatility funds only returned 5.81% over the identical period.
In emerging markets, the outperformance of riskier stocks was much more pronounced: Over the last decade, high-beta funds outperformed low-beta funds by 4.55 percent to 0.11 percent.
In fact, most low-volatility funds have didn’t sustain with even a broad market index. The average S&P 500-tracking mutual fund or ETF has returned 11.72% and 10.67% on an annualized basis over the past five and 10 years, respectively—significantly higher than low-volatility funds as a category.
All in all, despite the conceits of the low volatility anomaly, high volatility mutual funds and ETFs have delivered significantly higher returns over the past decade. Whether this trend continues over the following decade or was itself an anomaly shall be a crucial development to observe.
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