In investment literature, a low-volatility factor (LowVol) is well-known. Stocks with low volatility (and low market beta) show higher risk-adjusted returns than high volatility (and high market beta) stocks. That means we can gather premium having a long position of low-volatility stocks against a short position of high-volatility stocks, with corresponding ratios reflecting their beta difference.
There are some ETFs around this factor. Low-volatility stocks are selected into SPLV and USMV. High-volatility stocks are selected into SPHB.
Larry Swedrow writes that this factor works not because low-volatility stocks are especially good, but because high-volatility stocks show significant risk-adjusted underperformance against the broad market benchmark. The explanation: there is a class of investors who prefer "lottery" price properties in hope to get an outperforming returns, disregarding the risk. They make high-beta stocks relatively overpriced and that leads to its bad performance in future.
Let's take a look at ETF dynamics: broad market SPY against high-beta SPHB:
You can see that high beta stocks reaction on market corrections is stronger and they do not fully compensate it on bull markets. Despite the high beta, they underperform the broad market!
Here is the pair dynamics in volatility-normalized scale:
In volatility-adjusted scale SPY steadily outperforms SPHB.
Now we have an idea to use SPHB short position to hedge against market corrections. Maybe holding this short position all the time will be too expensive, SPHB is not very popular ETF to be available for short, you'd better check in advance what price you broker want for shorting it. But for a local hedge, when you're sure about close market correction, short SPHB position may work better than VIX-products or index put options.
There are some ETFs around this factor. Low-volatility stocks are selected into SPLV and USMV. High-volatility stocks are selected into SPHB.
Larry Swedrow writes that this factor works not because low-volatility stocks are especially good, but because high-volatility stocks show significant risk-adjusted underperformance against the broad market benchmark. The explanation: there is a class of investors who prefer "lottery" price properties in hope to get an outperforming returns, disregarding the risk. They make high-beta stocks relatively overpriced and that leads to its bad performance in future.
Let's take a look at ETF dynamics: broad market SPY against high-beta SPHB:
You can see that high beta stocks reaction on market corrections is stronger and they do not fully compensate it on bull markets. Despite the high beta, they underperform the broad market!
Here is the pair dynamics in volatility-normalized scale:
In volatility-adjusted scale SPY steadily outperforms SPHB.
Now we have an idea to use SPHB short position to hedge against market corrections. Maybe holding this short position all the time will be too expensive, SPHB is not very popular ETF to be available for short, you'd better check in advance what price you broker want for shorting it. But for a local hedge, when you're sure about close market correction, short SPHB position may work better than VIX-products or index put options.
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