Rewrite the Finance Textbook: Low Risk Offers High Return

By Usman Hayat, CFA

As investment professionals, we were taught wrong. We were taught capital asset pricing model (CAPM) and efficient market hypothesis (EMH), which are overly simplistic. And contrary to what we were taught, low-volatility stock portfolios consistently outperform. This was the bold assertion made by Nardin Baker, CFA, chief investment strategist at Guggenheim Partners, who spoke to a hall full of investment professionals at the CFA UK Annual Conference 2013.

Referring to “Low Risk Stocks Outperform within All Observable Markets of the World,” a research paper he coauthored with Robert A. Haugen, Baker added that not only do these low-volatility stock portfolios outperform, but they also outperform in all equity markets of the world across time. Baker and Haugen’s study extends from 1990 to 2011 and covers stocks in 21 developed markets and 12 emerging markets.

To critics who may be eager to point out the usual problems with the research methodology, such as survivorship bias, nonrepresentative samples, and replication issues, the paper offers an early clarification: “Our procedure is intentionally simple, transparent and easily replicable. Our samples include non-survivors. Our database includes 99.5% of the capitalization in each country.”

Read the rest here.