Explanation:
Low volatility strategies are known to exhibit the low-volatility anomaly, where stocks with lower volatility tend to outperform stocks with higher volatility on a risk-adjusted basis. When measured against standard market capitalization benchmarks (which are typically weighted by market cap and thus have higher exposure to high-volatility stocks), low volatility strategies often show significant positive alphas.
Key points:
The low-volatility anomaly is well-documented in financial literature and represents one of the persistent market inefficiencies that low volatility strategies aim to exploit.
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A portfolio manager at a pension fund is presenting on investment strategies during a training for newly-hired portfolio analysts. The manager discusses low volatility strategies, illustrates historical performance measures of firms that apply these strategies, and draws attention to the benchmarks used. Which of the following statements about low volatility strategies would be correct for the manager to make during the presentation?
A
The strategies tend to have significant alphas relative to standard market capitalization benchmarks.
B
The strategies tend to have negative alphas relative to dynamic factors such as value or momentum.
C
The strategies tend to generate high alphas over the risk-free rate but negligible alphas over any other benchmark.
D
The strategies tend to generate low alphas if the benchmark used is adjusted for risk and high alphas otherwise.
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