Low-volatility investing is traditionally considered a conservative tactic that reduces risk but yields unspectacular returns; however, a recent Research Affiliates study adds to a new school of thought that low-volatility U.S. stocks actually tend to outperform their peers.

Can investors who want to avoid the roller coaster of high-flying stocks and bubble trends while enjoying outperformance really have their cake and eat it, too?

Absolutely, according to Research Affiliates, a California investment management firm that used both long-term and short-term results of the S&P 500 Low Volatility Index versus the plain-vanilla S&P 500 Index and other stock asset classes to bolster its case.

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

Since 2008, low-volatility U.S. stocks have produced a 6.1 percent return versus 1.7 percent for large-cap U.S. stocks, -3.2 percent for global developed world stocks, and -0.6 for emerging market stocks, the analysis showed.

Over 10-year and 20-year periods, U.S. low-volatility stocks also typically outperformed other stock classes, Research Affiliates found.

The study concluded "career risk" discourages many professional money managers from recommending a low-volatility strategy, primarily to avoid being left behind during short periods of skyrocketing returns such as during the outset of the dot-com bubble in the late 1990s.

"But as long as prices aren't appreciating insanely, low-volatility portfolios don't consistently underperform during upward trending markets," the study noted.

"During the two most recent market collapses, the bursting of the high-tech bubble and the global financial crisis, the low-volatility strategies significantly outperformed traditional cap-weighted investing while effectively maintaining the desired low-risk profile."

As for why low-volatility investing works so well, even though it tends to throw out popular high-beta sectors such as technology and biotech, Research Affiliates offered several theories.

For instance, many investors can't afford to use leverage to boost their returns, so they use high-beta stocks as a proxy. Also, investors "irrationally use high-volatility stocks as lotteries" because gambling is attractive. Finally, analysts tend to produce high growth forecasts for high-volatility stocks, which temporarily pushes up their prices.

But according to Larry Swedroe, a principal and director of research for the BAM Alliance, the cat is already out of the bag when it comes to low-volatility investing, because it's already been "discovered" by the smart crowd.

Swedroe writes in a column for CBS MoneyWatch that "the current high valuations of low-volatility stocks makes their outperformance from these levels unlikely. At the very least, if you're tempted to put your toes into the low-volatility pool, you should be prepared for a potentially long period of underperformance."

If Swedroe is correct, the playing field with low-volatility stocks versus their higher-beta brethren has already been leveled, just as the concept may be going mainstream.

Editor’s Note: 5 Reasons Stocks Will Collapse . . . 

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