Observations

1. Low-volatility stocks have generated similar returns to high-volatility stocks with less than half the risk (FIGURE 1).

  • Downside losses can turn into an investor’s worst enemy because the deeper the loss, the greater the gain required to break even (FIGURE 2).
  • We found that low-volatility-oriented portfolios mitigated drawdowns nearly 40% better than the broad S&P 500 Index during negative years, yet still generated similar returns during positive years since 1970 (FIGURE 3).
  • Adding bonds or using structured products such as buffer ETFs1 may help reduce volatility and improve performance in negative periods; the drawback is that performance is dramatically reduced during positive periods (FIGURE 4).

2. Why low volatility now? Periods following elevated concentration, elevated valuations, and extreme outperformance for the riskiest stocks have often been associated with strong performance for less glamorous, steadier, low-volatility stocks.

  • In the last five years, high-volatility stocks have dominated performance, even relative to growth stocks. This is not only out of step with history, but also may portend a cyclical mean reversion (FIGURE 5).
  • Higher starting valuations have historically been associated with lower forward five-year returns. Current valuations for the top 500 stocks are significantly above their average since 1990. This is true for both the “magnificent” top-10 largest stocks or the next 490 ordinary stocks below them (FIGURE 6).
  • When S&P 500 Index returns fall into the range of average or below average, low-volatility portfolios have historically outperformed high-volatility portfolios (FIGURE 7).

So, is it possible to have your cake and eat it, too? Maybe. We would argue that after five years of underperformance, and considering the current historically elevated concentration and valuation of US equity markets, lower-volatility portfolios may be worth considering.

 

Research

Figure 1

As Risk Increased, Returns Stayed Relatively Stable 

2021 YTD Total Return Bar Chart

As of 5/31/24. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Based on the 1,000 largest US stocks by market cap. Equal-weighted portfolios based on quintiles of volatility score (Quintile 1 being the lowest volatility and Quintile 5 the highest). Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 2

Losses Rose Linearly, But Gains Needed to Recover Grew Exponentially 
Percentage return required to fully recover from a loss 

2021 YTD Total Return Bar Chart

Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 3

Low-Volatility Stocks May Help Mitigate Losses Without Sacrificing Returns
Average 12-month returns and drawdowns for a variety of risk-controlled portfolios 

2021 YTD Total Return Bar Chart

Chart data as of 1970–5/31/24. Please see below for portfolio definitions. Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 4

Diversifying May Reduce Risk, But Adding Bonds or Buffer ETFs Can Reduce Returns As Well
Since 1970

2021 YTD Total Return Bar Chart

As of 5/31/24. Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 5

High- and Low-Risk Stocks Have Shared Similar Returns and Swapped Periods of Outperformance
5-Year Portfolio Returns (1970–Present)

2021 YTD Total Return Bar Chart

As of 5/31/24. All of the portfolios in the chart above are unmanaged, hypothetical security groupings created exclusively for analytical purposes. Please see below for portfolio definitions. Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 6

Starting Points Matter to Forward Returns, and Today’s Valuations Are at One of the Higher Points in History
Top 500 US Stocks: Starting P/E Ratio vs. 5-Year Rolling Forward Returns (1970-Present)

2021 YTD Total Return Bar Chart

As of 5/31/24. Past performance does not guarantee future results. Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

Figure 7

Lower-Volatility Stocks Have Only Underperformed (On Average) During the Very Strongest Market Periods
5-Year Annualized Return (1970-Present)

2021 YTD Total Return Bar Chart

As of 5/31/24. Please see below for portfolio definitions. Data Source: Compustat. Calculation: Hartford Equity Modeling Platform.

To learn more about low-volatility investing, please talk to your Hartford Funds representative.

Figure 3 and 4 Portfolio Definitions:

Name Type Description
High Volatility Portfolio Bottom 30% of the US top 1,000 stocks based on a composite-volatility score defined by multiple equal-weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation.
Low Volatility Value Portfolio Top 50% of the top 1,000 US stocks based on a composite-volatility score and then cut 50% based on composite-value score defined by multiple equal-weighted valuation metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation and value metrics include: P/E, EBITDA/EV, operating cash flow/EV, revenue/EV, dividend yield, and B/P yield (used only in financials and real estate as a replacement to EBITDA/EV). Portfolios constructed using composite value are not neutralized or weighted at the sector level.
Low Volatility Portfolio Top 30% of the US top 1,000 stocks based on a composite-volatility score defined by multiple equal-weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation.
60/40 Portfolio A portfolio comprised of 60% S&P 500 Index and 40% IA SBBI US IT Government Index.
S&P 500 Index Index S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.
Buffer ETF Portfolio A hypothetical portfolio that caps upside return over a rolling 12 month period at 9% and downside return at 0%.

Figure 5 Definitions:

Name Type Description
High Volatility Portfolio Bottom 30% of the US top 1,000 stocks based on a composite-volatility score defined by multiple equal-weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation.
Low Volatility Portfolio Top 30% of the US top 1,000 stocks based on a composite volatility score defined by multiple equal-weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics 3-year beta and standard deviation.
SMID Cap Portfolio US small- and mid-market capitalization stocks.
Composite Value  Portfolio Top 30% of the top 1,000 stocks based on composite value as defined by multiple equally weighted valuation metrics to arrive at an aggregated valuation metric. Valuation metrics include: P/E, EBITDA/EV, operating cash flow/EV, revenue/EV, dividend yield, and B/P yield (used only in financials and real estate as a replacement to EBITDA/EV). Portfolios constructed using composite value are not neutralized or weighted at the sector level.
Quality Portfolio Top 30% of US top 1,000 stocks based on gross profits to assets.
Growth Portfolio Top 30% of US top 1,000 stocks based on trailing 1-year earnings growth.
Mega/Large Cap Portfolio US mega- and large-cap stocks.
Top 1000 Portfolio US top 1,000 stocks, cap-weighted.

Figure 7 Definitions:

Name Type Description
Low Volatility Value Portfolio Top 50% of the top 1,000 US stocks based on a composite-volatility score and then cut 50% based on composite-value score defined by multiple equal-weighted valuation metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation and value metrics include: P/E, EBITDA/EV, operating cash flow/EV, revenue/EV, dividend yield, and B/P yield (used only in financials and real estate as a replacement to EBITDA/EV). Portfolios constructed using composite value are not neutralized or weighted at the sector level.
Low Volatility Portfolio US Top 1,000 stocks top 30% based on a composite-volatility score defined by multiple equality weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation.
High Volatility Portfolio US Top 1,000 stocks bottom 30% based on a composite-volatility score defined by multiple equality weighted volatility metrics to arrive at an aggregated valuation metric. Volatility metrics include 3-year beta and standard deviation.