Why include volatility analysis in stock selection? There are three primary reasons why we include volatility analysis in our models. First, historically, low volatility stocks outperform high volatility stocks on average with less risk. Second, selecting stocks based on value characteristics alone exposes the investor to “value traps." This is the biggest risk to value strategies and their managers. Why is this? Most value strategies and their managers lack a built-in sell discipline and become deceived by lower stock prices. Volatility analysis benefits from a clear built-in sell discipline reducing the risk of "value traps" in our strategies. Lastly, volatility analysis provides superior margin of safety. Our strategies combine optimal volatility factors with fundamental value characteristics to enhance the upside volatility can offer, as well as the downside protection it affords.
Value investing focuses on, companies that embody solid balance sheets, are highly profitable, efficiently use capital, and have superior margin of safety. Historically, value strategies outperform the broader markets and more growth-oriented strategies. That said, value strategies can still have periods of underperformance. We created our MVVP strategies to integrate our volatility and fundamental value factors to reduce periods of underperformance and improve alpha generation. Combining our volatility and value factors results in a sustainable long run investment strategy that maintains optimal factor exposure with favorable upside capture while reducing numerous risk measures such as standard deviation and max drawdown.
This unique and complementary combination of volatility and high-quality value factors reflecting the most desirable fundamental characteristics. That's not enough for us and our clients.
Academic research and practitioner experience have shown a portfolio consisting of fundamentally sound companies trading at good prices is likely to beat the broader markets over the long run. This is where active investing plays a key role as we can focus on the stock-specific factor exposures while also improving the factor allocations within the combined portfolio. Our MVVP strategies utilize a superior allocation methodology replacing the archaic and flawed market capitalization methodology employed by most asset managers.
Our methodology is similar to passive investing in its rigorous, disciplined, and systematic approach of rebalancing the portfolio to maintain optimal exposure to our time-tested factors. In addition, our volatility factors introduce a built-in buy and sell discipline to take the emotions out of investing that plague most active managers.
The optimal combination of these elements results in what we call the Minimum Variance Value Portfolio “MVVP”