Low-Risk Investing. Without Industry Bets. Article Review

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“Low-Risk Investing Without Industry Bets” Article Review

The authors begin by informing the reader that low-risk investing is based on the concept that safer stocks deliver higher returns than riskier stocks when all the risks are adjusted. They refute the notion that the high returns are delivered because of the fact that industry bets favour stable industries. They argue that the strategy of investing in safer stocks delivers positive returns in all industries irrespective of bets. The authors specifically tested the extent to which the benefits of low risk investing tilt within industries. Low-risk investing is thus not purely driven by low-risk industries or the value effect. They considered various Betting-against Beta (BAB) factors. The study disclosed that when more risk is hedged by investing in low-risk stocks, one can attain higher returns.

The reason why safe stocks tend to result in higher returns is because many investors cannot leverage beyond a certain extent, therefore raising the required return for risk-averse investors (Bodie et al., 2013). Low-risk investments work across industries and deliver higher returns when more leverage is needed per unit of risk. Industry neutral BAB investments deliver positive returns in every industry in the United States and in most global industries. The fact is true for every 20-year period since 1929 in the United States and since 1986 in the international markets.

The study conducted by the author reveals that low risk investment is useful both for selecting industries and for selecting the most optimal stocks within an industry. Betting against high-risk stocks earns positive returns for both industry and industry stock selection when the risk level is adjusted. This is true for 60 out of 70 global industries and for all 49 industries in the United States. The statistically and economically strong low-risk investment phenomenon is neither driven by betting on industries nor by exposure to value. It is an independent variable that functions on its own as an automatic response to routinely established investment patterns.

The article is very articulate and straight to the point as the authors express sentiments that are backed by evidence and can be evidenced by the trends in national and global stock markets. Risks lie at the core of every investment and are the driving force of the investment world. A basic principle of investment is that investors tend to settle on the assets with the highest expected percentage of return for every unit of risk. They then use leverage to match their personal preference for risk. Safer stocks tend to have higher returns because it is not all investors who can use leverage and some investors are completely precluded from any form of leverage. Marginal requirements act as a leverage barrier for some investors.

According to Assnes et. al (2014), risk-seeking investors often undermine the power of leverage by tending to overweight risky securities resulting in the overpricing of such securities. The ability to exploit overpricing is often limited through prohibition by charters, the high expenses of shorting, and the unwillingness of investors to accept such risks because of the high possibility of incurring unlimited losses. High-cost stocks tend to have lower returns because the prices often go up then come down, forcing investors to liquidate at a loss. The authors are, therefore, right when they state that safer stocks result in high returns across all industries. This is because the risks are less in such stocks and prices continue to be relatively stable irrespective of the industry. Low-beta stocks capitalize on leverage to earn higher risk-adjusted returns.

In conclusion, low-risk investing is based on the concept that safer stocks deliver higher returns than riskier stocks when all the risks are adjusted, at least according to the authors of the article. In this regard, Low-risk investments work across industries and deliver higher returns when more leverage is needed per unit of risk. Subsequently, low risk investment is useful both for selecting industries and for selecting the most optimal stocks within an industry. Whether low risk or high risk, it is important to note that risks lie at the core of every investment and remain the driving force of the investment world.

References

Asness, C., Frazzini, A. & Pedersen, L. (2014). Low-Risk Investing Without Industry Bets. Financial Analysts Journal, 70 (4).

Kane, A., Marcus, A. J., Bodie, Z., & Mays Business School. (2013). Investment analysis: FINC 421: special edition for Texas A & M University. Boston: McGraw-Hill Learning Solutions.