Ed Croft's presentation at Mello London about the effect of risk on portfolio returns.

1. Achieving higher returns
from lower risk stocks

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Disclaimer

3. Ed Page Croft
Co-Founder & CEO Stockopedia.com
Wealth Manager turned programmer.
Highly motivated private investor.

4. Seminar Agenda
• A True Story
• On the nature of Risk & Return
• Volatility & Risk
• Performance Studies of RiskRatings
• An implementable low-risk strategy
• Q&A
30 mins
15 mins
15 mins

5. A True Story

6. High returns high risk?
Bitcoin

7. Risk
Return
Risk vs Return (theory)

8. Risk
Return
“I need to take higher risks to
get higher returns!”
Risk vs Return (theory)

9. Risk
Return
Risk vs Return
Cash
Bonds
Property
Shares
Across different asset classes

10. Risk
Return
Risk vs Return (reality)
In any single asset class (e.g. shares )Shares

11. 1990-2011 - Equity Returns across 21 countries
Haugen & Baker - 2012 - Low Risk Stocks Outperform within All Observable Markets of the World

12. Risk
Return
Risk vs Return (reality)
In shares (in the long term) there is no
additional reward for taking on extra risk.

13. Risk
Return
Risk vs Return (reality)
This is called the “low volatility anomaly”

14. Why is risk so attractive?

15. Some Explanations
• “The Lottery Ticket Effect” - Individual
investors have a preference for high-risk
stocks. They are always in a hurry.
• “Career Risk” - Institutional investors are
judged relative to benchmarks and can’t risk
underperforming - thus buying higher beta
stocks.
•“Option-like Compensation” - bonus
structures incentivise the chasing of higher
risk shares.

16. Option like Payoffs

17. Using volatility as a
proxy for ‘risk’

18. "In business schools… volatility is
almost universally used as a proxy
for risk. Though this assumption
makes for easy teaching, it is dead
wrong: Volatility is far from
synonymous with risk.”
Warren Buffett

19. Quantifying risk as ‘volatility’
Share B
Volatility
89% High
Share A 23% Low
Risk

20. RiskRating
A 5 level classification based on a
every stock’s annual volatility.
1. Conservative
2. Balanced
3. Adventurous
4. Speculative
5. Highly Speculative
Low Risk
High Risk
NB - Risk is defined as upside
and downside risk, rather than
the pure risk of capital loss.

21. A 5 level classification based on each
stock’s 3 year annualised & adjusted* daily volatility.
Volatility
< 25%
25%-35%
35%-45%
45%-70%
>70%
High Risk
Low Risk
1.Conservative
2.Balanced
3.Adventurous
4.Speculative
5.Highly Speculative
RiskRating
Annualised & Adjusted
* Bands vary over time

22. Market Segment in each RiskRating

23. RiskRating vs Size Group
Highly Speculative Speculative Adventurous Balanced Conservative
Small & Micro Caps
Higher proportion of
High Risk Shares
Mid and Large Caps
Higher proportion of
Low Risk Shares

24. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance History

25. Returns

26. Risk (Volatility)

27. Risk-Adjusted Return (Sharpe)

28. Risk “on” vs Risk “off”

29. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance History

30. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance History
“Great, I’ll just buy
conservative shares!”

31. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance History
But how would you feel if
you bought here?

32. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance “Risk On”
Oh no! I must change
my strategy!

33. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
RiskRating Performance “Risk Off”
-4%
-17%

34. *Annually rebalanced portfolios of LSE listed shares greater than £10m Mkt Cap. Past performance is not an indicator of future returns.
The Hare can’t catch the Tortoise

35. Didn’t you hear about the
Low-Volatility Anomaly?

36. Since 1929 - low risk returns 20x high risk
Source: Robeco

37. Some General Rules
1. Low Risk shares outperform long term & risk-adjusted.
2. Low Risk shares outperform in ‘risk off’ periods.
3. High Risk shares outperform in ‘risk on’ periods.

38. Warning!
Conservative stocks
are not low risk

39. Some 25% annualised volatility stocks

40. Don’t forget your school mathematics !
Normal Distribution

41. 68-95-99.7 Rule
Typical year 1 in 3 years 1 in 20 years
Conservative
Shares ±25% ±50% ±75%

42. The only free lunch in investing

43. Be careful with sector diversification
1. Conservative
2. Balanced
3. Adventurous
4. Speculative
5. Highly Speculative
9%
17%
25%
33%
15%
13%
20%
29%
24%
13%
3%
13%
26%
35%
21%
RiskRating

44. How can you improve
Low Volatility Returns?

45. 6% isn’t enough!!!

46. Conservative “Super Stocks”
12%
6%
* Annually rebalanced portfolios of £10m+ Mkt Cap stocks. Past performance is not an indicator of future results.
High Quality, Good Value, Strong Momentum

47. Conservative “Super Stocks”
High Quality, Good Value, Strong Momentum
Annualised Return Max Drawdown
Conservative Super
Stocks
11.9% -7.9%
Conservative Stocks 6.5% -6.9%

48. 8 Current Qualifiers
Conservative Super Stocks / High Flyers
Ticker Name Mkt Cap £m Stock
Rank™
Sector Fla
g
IMB Imperial Brands 23,524 92 Consumer Defensives
OCN Ocean Wilsons Holdings 410.2 99 Industrials
SHEP Shepherd Neame 163.4 94 Consumer Cyclicals
FIF Finsbury Food 142.8 83 Consumer Defensives
JEL Jersey Electricity 141.9 92 Utilities
THW Daniel Thwaites 85.2 87 Consumer Defensives
WYN Wynnstay 83.0 97 Consumer Defensives
CFX Colefax 54.7 97 Consumer Cyclicals

49. Reading Lists

50. High Returns from
Low Risk
by
Pim Van Vliet

51. The Missing
Risk Premium
by
Eric Falkenstein

52. http://www.stockopedia.com/books/riskratings/