The inverse relationship between volatility and returns is well known. Multiple studies have led to the commercial development of indexes that target low-volatility—and to the investment strategies designed to mirror them.
As a whole, empirical literature suggests that the low-volatility “anomaly” may actually be an artifact of a more nuanced phenomenon—investor preferences for positively skewed returns. Intuitively, investors chase “sure things,” thereby causing such stocks to become overpriced relative to fundamentals and leading to subsequent underperformance.
Our paper starts by investigating three attributes that the academic literature has associated with skewness expectations: idiosyncratic volatility, valuation, and profitability. We develop a simple framework to identify problematic stocks, and explain how this approach can improve performance over several widely used US and global capitalization-weighted stock indexes.