Low-volatility equity portfolios disappointed in 2013 because of hidden risks, according to a report from Unigestion.
“The disappointing behaviour of low-volatility stocks can be explained by their heavy sector concentration,” states the report. “Low-volatility stocks belong largely to non-cyclical industries such as utilities and telecom.”
The report notes that rising interest rates can also have an impact on low-vol stocks.
Historically, defensive sectors, such as pharmaceuticals and utilities, are the most exposed to the risk of an increase in interest rates.
Low-vol stocks exhibit a “short interest rates“ behaviour, meaning they would become more risky if interest rates rise, while high- volatile/cyclical stocks show “long interest rates” profile, meaning they would benefit if interest rates rise.
Minimizing past volatility is not enough to build a portfolio with low future downside risk. Past volatility may hide some additional risks, which are not self-evident in more traditional assessments of stocks.
“Furthermore, our analysis confirms that portfolio diversification is not a guarantee of risk mitigation either,” the report notes. “We have seen that a thorough assessment of the structural interest rates risk embedded in an equity portfolio is crucial, particularly in portfolios constructed using past volatility estimates.”
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