Abstract
The portfolio of low-volatility stocks earns high risk-adjusted returns over a full market cycle. The annual alpha spread of low versus high-volatility quintile portfolios is 25.53% in the Indian equity market for the period from January 2000 to September 2018. The low-volatility (LV) effect is not an overlap of other established factors such as size, value or momentum. The effect persists across various size buckets (market capitalization). The performance of the low-volatility effect within various size buckets is analyzed using three different portfolio formation methods. Irrespective of the method of portfolio construction, the low-volatility effect exists and it also generates economically and statistically significant risk-adjusted returns. The long-short portfolios across the study deliver exceptionally high and statistically significant returns accompanied by negative beta. The low-volatility effect is not restricted to small or illiquid stocks. The effect delivers the highest risk-adjusted returns for the portfolio consisting of largecap stocks. Though the returns of the portfolio comprising of large-cap LV stocks are lower than the returns of the portfolio comprising of small-cap LV stocks, its Sharpe ratio is higher because of less risky nature of large-cap stocks as compared to small-cap stocks. The LV portfolio majorly comprises of large-cap, growth and winner stocks. But within size buckets, large-cap and mid-cap low LV picks growth and winner stocks, while small-cap LV picks value stocks.
Highlights
India is the world’s third largest economy in terms of purchasing power parity
Though the returns of the portfolio comprising of large-cap LV stocks are lower than the returns of the portfolio comprising of small-cap LV stocks, its Sharpe ratio is higher because of less risky nature of large-cap stocks as compared to small-cap stocks
Developed primary and secondary markets have attracted the FIIs/FPIs in India. They are regulated by Securities Exchange Board of India (SEBI)
Summary
India is the world’s third largest economy in terms of purchasing power parity. According to Asian Development Bank (ADB), it is the world’s fastest growing major economy with 7.3% growth rate in 2018–2019. It is seeking to achieve better growth by reshaping the policy approaches to human development, social protection, financial inclusion, rural transformation and infrastructure development. It is the dominant economy in the South Asia sub-region with its growth gaining momentum. Foreign Portfolio/ Institutional Investors (FPI/FII) have been one of the biggest drivers of India’s financial markets and have invested around USD 172 billion in India between FY0218. Developed primary and secondary markets have attracted the FIIs/FPIs in India. They are regulated by Securities Exchange Board of India (SEBI). Even the Indian mutual fund industry has shown an exponential growth in investment since 2003 (see Figure 1)
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