Pim van Vliet is a Dutch portfolio manager for the quantitative equities team at Robeco. He’s the author of different scientific papers and books, primarily about low-volatility investing. In his book ‘High returns from low risk: a remarkable stock market paradox’ he devised a strategy that provides above-market returns by investing in low volatility stocks.
The Capital Asset Pricing Model (CAPM) is widely used to predict the risk of investments. The model assumes that returns can be predicted by a linear model that uses volatility of the asset compared to the market. While this model was widely adopted throughout the finance industry, different academics soon challenged the assumptions used as they were not supported by empirical evidence. One of the first to do this was professor Robert Haugen, who questioned the methodology used to produce the supporting empirical evidence. (link: click here) Different studies confirmed Mr Haugen’s findings, however as it was counterintuitive, the investment community still uses the CAPM to this day.
Pim’s conservative stock formula
Pim built his strategy around this low-volatility anomaly or investment paradox, but he added two other factors into the mix.
- First he added a value component as he wants to detect stocks that were temporarily ‘on sale’. Stocks that generate a higher income for their shareholders compared to the value of the company are preferred. Pim measures income as dividends and share buybacks.
- Secondly, he added a momentum factor as some stocks might be cheap for a reason. Some stocks are value traps and even if they’re relatively cheap, there might not be any catalyst for recovery. As momentum factor, Pim uses the 12-month price index.
To get the list of stocks, Pim runs through the following steps:
- Start from a universe of the largest 1.000 stocks available. (Pim uses only US stocks in his book)
- Take the 500 stocks with the lowest volatility. (Pim uses 3-year volatility. In our template we use 2-year volatility as volatility over a 3 year period is not available)
- Select the top 20% of these stocks based on the combined raking of shareholder yield and 12-month price index. Buy these stocks.
- Repeat the process quarterly and rebalance the portfolio.
This formula selects:
low-risk companies that ‘conservatively’ deploy their capital, as they would rather distribute money to their shareholders than spend it on corporate activities themselves. The formula is also ‘conservative’ with regards to the timing. These stocks are only included when their business momentum improves and other investors have started to bid up their prices.
The author backtested this model over the period 1929-2015 and found that this model generated a 15% return per year. Compared to a portfolio of high-volatility stocks, it also proved to be more stable during more difficult periods.
Click here to go to Pim van Vliet's website.
The conservative formula in Valuesignals
Pim was so kind to provide us with guidance and feedback on how to best build his screen. We took the following steps:
- Set the minimum market Cap to $4,000m.
- Select the top 50% stocks with lowest volatility
- Create a custom factor based on shareholder yield and 1Y price index. Sort the results by this factor.