10 low volatility stocks for investors seeking shelter from uncertainty

Low risk equals high reward, writes Stockopedia's Ben Hobson who names the low volatility shares that do much better in periods of uncertainty and over the long term.

2018 has been a pretty quiet year for UK quoted shares. After two years of solid gains, the UK's main indices have flattened out. For those who worry about stretched valuations, or even bubbles in equity prices, periods of calm like these can be welcome.

But for others the drift in prices can be symptomatic of creeping uncertainty, especially when it comes to macro issues. Right now, Brexit looms large and President Trump's trade war with China is causing angst in some parts. You could argue that a lot could go wrong in the months ahead, and UK markets could be in for some stormy weather. 

Predicting the outcome of these events is impossible. But one way of taking comfort and positioning a portfolio to deal with potential volatility is to look at how individual stocks tend to be buffeted by the market. Those that are less volatile could be a preferred option for investors who are worried about the impact of market uncertainty.

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Over the past few years, growth and momentum have outpaced strategies like value and dividend investing. That's because investors flock to fast-moving stocks in up-markets. But it’s also true that speculative growth shares can suffer the most when market sentiment changes.

This means that during downturns, shares that are less sensitive to the market mood could be a safer option. While low volatility shares don't tend to outperform in bull markets, they do much better in periods of uncertainty. In fact, over the long term, low volatility - which essentially means taking less risk - has been shown to be the superior approach.

This 'low-vol anomaly' was a finding of the late Professor Robert Haugen, who wrote in detail about low-volatility outperformance existed. He concluded that investor behaviour was behind it and that there was a misconception that high risk equals high reward. 

Haugen believed that investors were overconfident in their own stock selection abilities and naturally attracted to risky shares. As a result, these shares would become overpriced, while lower risk shares would actually become cheap to buy. And while these cheaper, low-vol stocks are slower to rise in bull markets they don't fall as far in bear markets. 

Figuring out what makes a low volatility stock

Calculating volatility in the stockmarket is not simple. One of the measures used is called Beta. This is a direct measure - often taken over several years - of how sensitive a stock price is to the movement of the wider market. If a stock's price tends to rise more than the market on up-days and fall more than the market on down days, it will have a Beta greater than 1. But if it isn't as sensitive to market movements, rising, or falling, less than the market, then it will have a Beta of less than 1.

Another option is to look at a stock's standard deviation. This is a mathematical way of understanding how much a company's share price moves away from its average over a period of time. 

To simplify all this, we've built a low volatility screen this week which focuses on three-year standard deviation. But instead of numbers, we're using something called RiskRatings, which score stocks as either Highly Speculative, Speculative, Adventurous, Balanced or Conservative. For our purposes, we've focused on FTSE companies using the following rules:

-    Low bankruptcy risk (using the Altman Z-Score)
-    Attractive valuation, quality and momentum - shown here in the StockRank Style
-    A Beta of less than 0.8
-    Only Balanced and Conservative RiskRatings

Source: Stockopedia           Past performance is not a guide to future performance

Many of the stocks passing these rules have reputations for being solid, dependable companies. Many have outstripped the market over the past year, including the likes of Croda, Royal Mail and John Laing. And while safer investment profiles can be found in large-caps like BAE Systems and Smith & Nephew, it's also possible to get the same exposure in much smaller stocks like Costain Group, Avon Rubber and Fuller Smith & Turner. 

So, after a racy couple of years for growth and momentums stocks, 2018 has been a quieter affair. But against the backdrop of an uncertain macro picture, there could be trouble ahead for some of the most expensive, higher-volatility stocks if sentiment in the market changes. 

So, it could be worth planning for how to deal with a period of uncertainty by exploring where lower volatility can be found. Low volatility stocks are often better placed to withstand the challenges of market turmoil, which means they're a useful way of diversifying risk in a portfolio.

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