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Investment in low volatility index stocks - A winning strategy for risk-averse investors

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Dr. Pradeep Kumar Mitra

In the last one year the stock market has witnessed a huge downward swing where the bench mark index (NIFTY 50) has provided a negative return of almost 4.2%. The carnage in the Midcap index (-21.70%) and Small cap index (-28.70%) returns is now too heavy for the common investors who joined the zeal of market in the financial year 2017-18 and continued to pour funds in the market. The common investors are generally risk averse but they get many times carried away with the bullish fever in the market and ultimately repent on it. Risk aversion means that investors naturally try to avoid risky investments and when they are put into a risky situation they demand for more return. As such equity investment is a high risk instrument but the risk can be lowered if an investor invests in low volatility stocks. A low volatile stock means fewer fluctuations in its daily charts and normally has lower beta which is close to 1 or less. So pertinent question is whether investing in low volatile stocks can save investors from these swings and give a better sleep in the night with a handsome equity exposure in their portfolio. The portfolio at the same time should provide a better risk adjusted return that outperforms the index return.

BSE has introduced a low volatility stock index on Dec 03, 2015 which includes 30 stocks having low volatility. Idea is to understand how these stocks have performed with respect to a market index and whether could generate consistent returns for the investors. This article tries to identify the stocks’ performance included in BSE low volatility index and finds how they have performed over and above the benchmark yield of Government Bonds which is considered to be the risk free rate. Stock’s performance is measured through excess return to beta ratio popularly known as Treynor ratio. All the stocks’ three years average monthly returns are taken into consideration using log normal return. The risk free rate is considered to be the three years’ benchmark yield of 10 years Government Bond which comes to 0.6275% on a monthly basis. The excess return to beta is calculated as the ratio of stock’s excess return over the risk free rate and the stock’s beta. A stock return is said to be outperformed if its excess return to beta ratio is more than the index. The analysis was made on a data set of 3 years’ monthly closing of the selected stocks and index for a period of three years starting from January, 2016 to December, 2018.

 Company  Average monthly Return (%)  Beta of stock  Excess return to Beta
 NIFTY  1.03423  1  0.406729842
 HINDUNILVR  2.071829323  0.775779323  1.861778575
 BRITANNIA  2.066746507  0.814418038  1.767208535
 HDFCBANK  1.870188475  0.857709156  1.448845994
 RBL BANK  2.525986299  1.442978563  1.315671867
 PIDILITIND  1.926537783  1.080222617  1.202564881
 MRF  1.447074276  0.748254523  1.09531483
 MARICO  1.398879806  0.710541718  1.085622119
 NESTLEIND  1.793315464  1.198776791  0.9725042
 KOTAKBANK  1.548489822  1.187934113 0.775286956
 LT  1.460039109 0.646378384 0.775286956
 ASIANPAINT  1.229776778  0.977613725 0.616068251
 TCS  1.222028994  1.071369604 0.554924269
 INDUSINDBK 1.39210667  1.37910136 0.554423839
HDFC   1.235613488  1.121541568 0.542212171
DABUR 1.23204353 1.152227123 0.524673928
POWERGRID 0.953131944 0.634294896 0.513376263
COLPAL 0.89989272 0.642207502 0.424150636

Data source: Money Control & Yahoo Finance

Out of all the stocks available in the low volatility index 17 stocks have generated excess return to beta higher than that of NIFTY thereby outperforming its return. If anyone invests in NIFTY Bees or Index Fund it is considered to be a passive investment strategy. But with low volatile stocks one can work out an active investment strategy which is less risky and can generate better risk adjusted return compared to the market return (NIFTY). Though one may argue that past return may not be an indication for future return but it is evident that the portfolio of these 17 low volatile stocks has consistently provided a better risk adjusted return and thereby may be a winning portfolio for the risk averse investors.