Interactive Investor

10 stocks that could offer protection from market volatility

12th April 2017 14:13

Ben Hobson from Stockopedia

Stockmarket volatility has dropped to historically low levels recently. While political events in the UK and US caused brief spasms in prices last year, the general trend has been calm. Against this backdrop equity prices have been rising nicely, but there are signs that things are changing.

There are various reasons why markets become very unsettled, and periods of high and low volatility often tend to be cyclical. As a result, shares that are less sensitive to the market mood often appeal to risk-averse investors.

While the strategy typically underperforms during bullish conditions, low-vol stocks have actually been shown to outperform over the long term.

The late Professor Robert Haugen wrote extensively about why low-volatility outperformance existed. As a critic of the concept that markets are highly efficient, he claimed that investor behaviour was behind the phenomenon.

Haugen found that investors - including institutional funds - tend to believe the idea that high risk equals high reward. Overconfident in their own stock-picking abilities, they are drawn to risky shares like a magnet.

That popularity causes those shares to become over-priced. By contrast, lower-risk stocks can become cheap, and while they are slower to rise in bull markets they don't fall as far in bear markets.

Up until the middle of 2016, the "low-vol trade" had been very popular, and flows into low volatility funds were surging. But after the EU referendum, sentiment switched away from safety and investors became "risk on".

The bull run since last summer has been driven by the popularity of growth stocks, which naturally tend to be more volatile.

So where does this leave us? Depending on how you view these trends, there's a risk that volatility could once again be on the horizon.

For a start, the relentless gains we've seen since last summer could slow as investors face up to increasing economic and political uncertainty. With Brexit negotiations about to start, and international political backdrop (notably Russia and North Korea) causing concern, there are reasons to worry.

What is a low-volatility stock?

Calculating risk in the stock market is not simple. But one of the measures used in the study of volatility is something 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.

It wouldn't give you the full picture of volatility, but it can be used as a risk indicator to show how exposed your portfolio is to riskier stocks.

Stockopedia created a screen for Interactive Investor that looks for FTSE 350 shares with a beta of less than 1. We then sorted it for those with the best overall combination of quality, value and momentum factors - which we call the StockRank.

We also added a red flag indicator in the form of the Altman Z-Score, which weeds out stocks with any hint of bankruptcy risk.

With the exception of Halfords, all the shares passing these low volatility rules have seen positive price strength over the past year.

Media group Euromoney Institutional Investor leads the list, with some of the others including Telecom Plus, which runs Utility Warehouse, engineering group Ultra Electronics, the housebuilder Crest Nicholson and supermarket group Wm Morrison.

In a period of rising prices and relative calm in the UK stock market, tackling volatility is perhaps the last thing that some investors will be thinking about. Yet the cyclical nature of volatility means that it ought to be a constant consideration.

Low-volatility stocks are arguably better positioned to cushion the blows of sudden market turmoil, which means they're a useful way of diversifying risk in a portfolio.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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