Volatility, quantified as standard deviation, serves as a crucial indicator. A fund with high volatility is prone to significant deviations from its average return, which can dampen investor sentiment and create anxiety. Consequently, for those who prioritize peace of mind regardless of market cycles, it is prudent to focus on funds offering higher returns per unit of risk.
Let’s understand this with the example of two hypothetical funds. Both achieved a 24% return over the past year, but their levels of volatility differ. The first has a standard deviation of 12%, while the second exhibits a standard deviation of 18%. The ratio of risk-adjusted returns for the first fund is 2, while the second scores 1.3—making the first fund inherently superior, offering a better investor experience even during market downturns. Its lower volatility mitigates downside risk and limits portfolio erosion, whereas the second fund is more vulnerable to significant drawdowns during major corrections.
For risk-averse investors, this example emphasizes the importance of selecting funds where stocks are chosen based on low volatility. The primary measure of performance should be risk-adjusted returns, not absolute returns. Recognizing this growing demand, asset management companies are increasingly launching minimum-variance funds or funds curated with low-volatility stocks. These options aim to deliver reasonable long-term returns while reducing the fear of market corrections caused by macroeconomic factors or earnings-related disruptions.
It’s important to dispel the myth that low-volatility stocks yield lacklustre returns or are confined to counter-cyclical sectors. Historical evidence suggests otherwise. The performance of low-volatility stocks hasn’t only matched but often surpassed benchmark indices over the long-term. For instance, the Nifty 100 Low Volatility 30 Index has delivered an impressive 18.4% annualized return since 2005, compared to the 14.8% return of the Nifty 50 Total Return Index (TRI). Furthermore, the low-volatility index has outperformed the Nifty 50 TRI approximately 60% of the time during this period.
Low-volatility stocks exhibit resilience during market downturns, but more importantly they have the ability to capture substantial gains during market upcycles. Take, for example, the recent bull phase driven by strong earnings momentum, spanning June 2022 to September 2024. During this period, the Nifty 100 Low Volatility 30 Index delivered a return of 32%, outperforming the Nifty 50 Index by a significant margin of approximately 400 basis points. This performance demonstrates that low-volatility stocks not only offer downside protection but also participate meaningfully in market rallies.
Investors seeking consistent growth with minimal risk should ideally prioritize low-volatility stocks in the large-cap segment. These stocks not only provide attractive capital appreciation but also safeguard against excessive risk. The pursuit of higher-risk funds in hopes of massive returns often proves unwarranted, especially when low-volatility options deliver such compelling risk-adjusted results. By opting this approach, investors can achieve financial growth by weathering the market fluctuations with confidence.
The author of this article is Akash Mahesh Kothari, Mutual Fund Distributor.
NOTE: This is partnered post.
