T H E

J O U R N A L

THEORY & PRACTICE FOR FUND MANAGERS

O F

FALL 2013 Volume 22 Number 3

RISKBASED
PORTFOLIOS

special section

The Voices of Influence | iijournals.com

Pursuing the Low Volatility
Equity Anomaly: Strategic
Allocation or Active Decision?
ERIK KNUTZEN

ERIK K NUTZEN is the chief investment officer at NEPC LLC in
Cambridge, MA. eknutzen@nepc.com FALL 2013

JOI-KNUTZEN.indd 75

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n the past several years, asset managers have built investment strategies based on historical evidence that lower volatility stocks earn superior risk-adjusted returns. These approaches are being called low volatility, managed volatility, minimum variance, or similar names. They seek to exploit what has been identified in studies by academics and practitioners alike as an equity pricing anomaly. This anomaly joins previously identified persistent stock market inefficiencies associated with low price-tobook and smaller company shares.
This article evaluates the low volatility anomaly, its potential causes, whether it is likely to persist, and the role, if any, of low volatility equity investing in long-term investment programs.
Based on historical information, we conclude that the low volatility equity anomaly appears to exist and can be explained by certain behavioral and structural biases of investors. But its continued existence into the future is less certain. We also observe that even well-documented anomalies experience multi-year periods of outperformance and underperformance relative to broad market benchmarks such as the
Standard & Poor’s 500 Index. These episodes of relative under- and overvaluation appear to be driven by market fundamentals and investor behavior.

Therefore, we believe that any effort to capture a particular anomaly should be viewed as an active decision, requiring a valuation