low risk investing: Pim Van Vliet’s tips on how to generate market-beating returns by taking lower risk

Renowned investor Pim Van Vliet says most investors believe that risk and return are inseparable and in order to achieve higher returns they need to take on greater risk.

“It is because we define risk in the wrong way. But when I was able to reconcile the paradox and started to research and apply the knowledge I was accumulating, by managing low-risk funds for investors, we were able to generate high risk- adjusted returns by investing in low-risk stocks, which attracted billions of dollars, “he said.

According to Van Vliet, low-risk stocks can outperform high-risk stocks dramatically over the long term.

“They don’t do it every year. In fact, high-risk shares do outperform in bull markets. But low-risk shares outperform to such an extent in bear markets and sideways markets that their overall ‘full cycle’ performance smashes that of high-risk shares, “he wrote in his book ‘High returns from low risk: A remarkable stock market paradox’.

Pim van Vliet is a Dutch portfolio manager and the founder and fund manager of multi-billion Conservative Equity funds at Robeco and is an expert in the field of low-risk investing.

Vliet holds a PhD and an MSc in Financial Economics from Erasmus University Rotterdam. He also delivers guest lectures at several universities where he advocates low-volatility investing and is the author of numerous financial books.

His low-risk fund portfolios are based on extensive academic research and provide investors with a steady source of income from the stock market.

How low-risk portfolio can offer market-beating returns
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.

Together with investment specialist Jan de Koning, Van Vliet presented a counterintuitive theory where he used the analogy of the famous Tortoise and the Hare story to explain that a low-risk portfolio beats a high-risk portfolio because it is slow and steady.

“The high-risk Hare keeps taking a nap while the Tortoise takes the line honors. It never races ahead, but it can recover from market declines more quickly than the high-risk portfolio,” he says.

According to Van Vliet, high returns from low risk give all the tools investors need to achieve excellent, long-term investment results.

‘Most people want to bet on hares. In psychology, finance and literature it’s the moves in the market that generate the most attention and they drive up prices in stocks, which in turn makes the news. Tortoises are never in the news. Volatility makes headlines – this exacerbates a culture of short-termism and people who are bullish and want a quick buck, “he says.

How to construct a winning portfolio
According to Van Vliet, investors need to have a patient approach towards investing and should use momentum, as well as low risk, to construct a winning portfolio.

“Win by not losing. It’s a patient approach that most investors would be wise to put into practice, but which I’m sure most will ignore. The reality is that investors just can’t help themselves and end up losing money in the risky end of the market! ” he said.

According to him, ranking stocks on three parameters such as low volatility, high dividend yield and rising momentum can yield terrific market-beating results.

Van Vliet conducted extensive research with stock market data going back to 1929 to prove that investing in low-risk stocks gives surprisingly high returns, significantly better than those generated by high-risk stocks.

Van Vliet’s research starts by selecting the 1,000 largest stocks based on market cap and then he reduces that group further by eliminating the 500 most volatile stocks using standard deviation.

The remaining stocks are selected based on their net payout yield by looking for firms with high dividends that are also buying back their stocks, and their intermediate-term momentum using 12-month momentum, excluding the most recent month.

In the end, Van Vliet shortlists a group of low volatility stocks that are focused on returning capital to shareholders and have been performing well relative to the market. Van Vliet repeats the process quarterly and rebalances the portfolio from time to time.

Van Vliet 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 tougher periods.

Van Vliet’s conservative stock formula
After building his strategy around this low-volatility anomaly or investment paradox, Van Vliet added two other factors into the mix.

First, he added a value component as he wanted to detect stocks that were temporarily ‘on sale’.

He preferred stocks that generated a higher income for their shareholders compared to the value of the company. He measured income as dividends and share buybacks.

Secondly, he added a momentum factor as some stocks were cheap for a reason.

According to Van Vliet, some stocks are value traps and even if they’re relatively cheap, there might not be any catalyst for recovery. As the momentum factor, Van Vliet uses the 12-month price index.

“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, “he says.

Why investors should prefer low-risk funds
According to Van Vliet, there is a fine line between being ‘bullish’ and ‘reckless’ when it comes to investment.

He says investors, in general, are too quick to ‘shun’ more defensive equity funds.

“For this reason, society is experiencing a collective sense of over-confidence that they want to invest in high-risk funds. This is really good for people’s mental wellbeing but it’s bad for financial health,” he says.

According to Van Vliet, these defensive equity funds are like tortoises which are stable companies and defensive funds that ‘never seem to go up’ in stock market terms but in the long run lead to a good end result.

“To capitalize on the low-risk anomaly, a long-term investment vision is required. The advantage of a low-volatility strategy is that the stocks involved will fall less than other stocks in a declining market. Once the market recovers, low- volatility stocks have less ground to make up to recover and start yielding positive returns again, “he says.

What investors can learn from Buffett

Giving an example of the legendary investor Warren Buffett, Van Vliet explains that Buffett is inclined to take a long-term view when it comes to his investments and instead of following the crowd, he has built his career and success on seeking out undervalued investments.

Although Buffett’s portfolio has lagged behind the market several times during his career, he has beaten the market average decisively over time.

“For Buffett, the average is doing what everybody else is doing; to rise above the average, you need to measure yourself by what he terms the ‘inner scorecard’ – judging yourself by your own standards and rather than the world’s,” he says .

Should new investors be financial experts to understand the market?

Van Vliet says the secret to successful investing is wisdom rather than market knowledge only.

“I think a good philosophy for investment is” some risk “. Putting this into the context of diet, a moderate amount of vitamins and salt is a good thing – but not taken to the extreme. There is no such thing as” no risk “As the risk spectrum is not linear. You have to create a bit of risk to generate value. If there is no risk, your investments will be negative. I believe the ideal investment choice is what I call the” conservative middle “, which is a situation between very high and very low risk, “he says.

(Disclaimer: This article is based on Pim Van Vliet’s book ‘High returns from low risk: a remarkable stock market paradox’)


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