• Alex Vikner

High Returns from Low Risk by Pim van Vliet

Most investors operate with the traditional risk-return tradeoff in mind: higher returns come with higher risk. Van Vliet illustrates that this deeply rooted belief is nonsense and that in fact, low risk stocks outperform high risk stocks over the long term.


The Tortoise & The Hare

Aesop's fable concerns a Hare who ridicules a slow-moving Tortoise. Tired of the Hare's arrogant behaviour, the Tortoise challenges him to a race. The hare soon leaves the tortoise behind and, confident of winning, takes a nap midway through the race. However, when the Hare awakes he finds that his competitor, crawling slowly but steadily, has arrived before him.


Similarly, within the stock market universe, high risk stocks outperform in bull markets. But low risk stocks outperform to such an extent in bear markets and sideways markets that their overall full cycle performance is better than that of high risk stocks. The high risk Hare keeps taking a nap while the low risk Tortoise takes the line honours.


With more than 86 year’s of stock market data Van Vliet shows that from a universe of the 1000 largest US stocks, buying the 100 lowest volatility (lowest risk) stocks and rebalancing the portfolio quarterly returned 10.2% annually versus 6.4% for the highest volatility stocks. This becomes quite a difference in portfolio size over the decades.

This message is particularly relevant right now as we find ourselves in a very speculative phase for the stock market. High risk stocks like Tesla have seeing immense growth which cannot last forever. Holding conservative shares at the core of a portfolio makes a lot of sense - it might help minimise any downside.


Amping up Low Risk Returns with Income & Momentum

To maximize returns Van Vliet recommends a multi-factor strategy. The idea is to combine exposures to multiple drivers of returns (a.k.a. factors) to soften the effect of drawdowns and increase the potential for outperformance.

  1. Rank the 1000 largest US stocks by volatility and discard the 50% highest risk (highest volatility) from the set.

  2. Rank the remaining stocks simultaneously by dividend yield size (income), and the performance of their 1 year share prices (momentum).

  3. Buy the top ranked 100.

With this more advanced strategy he amps up the returns to 15% annualised over 86 years. And during these 86 years there isn’t a single decade that sees losses. Quite impressive. The key message is that using Momentum, as well as Low Risk, in portfolio construction ensures that there is enough participation in bull markets, as well as downside protection in bear markets.


In Sum

Win by not losing. Most investors lack patience and end up losing money in the risky end of the market! As the saying goes: only dead fish go with the flow.