Low volatility sector-based portfolios: a South African case

Abstract

Portfolios and indices that have been specifically constructed to have low risk attributes have received increasing interest in the recent international literature. It has been found that portfolios constructed by targeting low risk assets have predominantly outperformed portfolios constructed to have higher risks. This anomaly has led to renewed interest in constructing low volatility portfolios by practitioners. This study analyses a variety of low volatility portfolio construction methodologies using sectors as building blocks in the South African environment. The empirical results from back-testing these portfolios show significant promise in the South African setting when compared with a market capitalization-weighted benchmark. In the empirical analysis in the South African environment two techniques stand out as being superior low volatility construction techniques amongst the seven techniques assessed. Furthermore, the low volatility portfolios are blended with typical general equity portfolios (using the Shareholder-Weighted Index (SWIX) as a proxy). It was found that these blended portfolios have useful features which lead to enhanced performance and therefore can serve as effective portfolio strategies.

Are South African equity investors rewarded for taking on more risk?

“…Contrary to the theoretical expectation, the results suggest a negative relation between risk and return. However, the result is in line with previous findings (see Khuzwayo 2015;Oladele & Bradfield 2016;Panulo 2014).…”

“…The results in this study are also consistent with those of Ang et al (2006), who found large negative alphas for US shares with high idiosyncratic volatility. The results could also explain the outperformance of the various low-volatility trading strategies investigated by Khuzwayo (2015), Panulo (2014) and Oladele and Bradfield (2016).…”

“…This study did not specifically control for potential sector bias within volatility sorted portfolios, so it is possible that some of the observed low-volatility effect could be explained by sector concentration as suggested by Khuzwayo (2015). However, even after controlling for sector bias in the low-volatility trading strategies investigated, Oladele and Bradfield (2016) found that these strategies outperformed.…”

“…In an endeavour to provide investable low-volatility portfolios in the South African equity market, studies such as Khuzwayo (2015), Oladele and Bradfield (2016) and Panulo (2014) evaluated the relative out-of-sample performance of different low-volatility strategies. Khuzwayo (2015) tested the performance of the minimum variance portfolio as proposed by Clarke, De Silva and Thorley (2011) to a similarly constructed high-volatility portfolio.…”

“…Over the 1995-2013 period, this study found significant outperformance of the low-volatility strategies relative to the FTSE/JSE All Share Index (ALSI). Controlling for sector effects, Oladele and Bradfield (2016) employed seven sector-based low-volatility portfolio strategies. They detected outperformance of all seven strategies relative to the ALSI over the 2003-2013 period.…”