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Can You Get Higher Returns from Low-Risk Stocks?

The concept of high-risk, high-return is a bedrock belief in finance, confirmed by decades of empirical data. But when Prof. Roger Ibbotson dug deeper into the data, things started to look a little different.

In finance, it’s a core belief: the higher the risk, the higher the return. Only “buy low, sell high” is more fundamental.

Roger Ibbotson, professor in the practice emeritus of finance and the founder of Ibbotson Associates and Zebra Capital, isn’t exactly a heretic, but he doesn’t view the concept of high risk, high return as absolute. In fact, in some instances, he’s found, lower risk is associated with better returns.

Working with Daniel Kim, research director at Zebra Capital, Ibbotson analyzed the performance of thousands of stocks from 1972 to 2013, categorizing them based on factors such as beta (volatility as compared to the market as a whole), value or growth orientation, market capitalization, and liquidity. The researchers focused on the U.S. stock market, as previous studies had shown that higher-risk asset classes outperform lower-risk ones. For example, stocks have better long-term returns than bonds. The expectation was that even within a market, this would hold true. Instead they found that portfolios of lower-risk stocks —the less volatile, value-oriented, bigger, and less liquid—chosen from the universe of U.S. stocks brought the higher returns, and often “quite dramatically.”

“This is something very counter to theory,” Ibbotson said. “But things don’t seem to work within a stock market like they work across markets.”

What’s the explanation for this unexpected result? According to Ibbotson, it comes down to popularity. “People like stocks that are exciting; they like growth stocks; they like stocks with stories attached to them,” he said. “But some things are always unpopular. What we’re saying is if you go after something unpopular, you’ll get better returns.”

Department: Research