A new report by Refinitiv’s StarMine research team unpacks the actual versus the expected impact of the COVID-19 pandemic on equities, looking specifically at volatility and the Sharpe Ratio.
- The unique nature of the COVID-19 pandemic had – and continues to have – a plethora of ripple effects, including those impacting returns on equities.
- During the pandemic, attention turned to technology-driven companies able to operate with no physical presence, exemplifying a shift from these companies being previously viewed as more volatile in nature, but which were now viewed in a more favourable light given their ability to operate in the cloud.
- As the popularity of such companies rose, so too did their stock prices, creating this unusual, crisis-driven finding: more volatile stocks were delivering higher returns.
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Refinitiv StarMine analysts conducted extensive research based on stock returns in the U.S. and other geographic regions over the period 31 December 2019 to 31 December 2021 – a time when the full impact and effects of COVID-19 were unfolding.
The study aimed to drill down into market behaviour during an unprecedented time of crisis and deliver insights into actual stock performance over this period.
Two key findings stand out:
1. The low volatility anomaly did not hold true
This anomaly is a well-tested theory that asserts that volatility and returns have an inverted relationship. In other words, the most volatile stocks offer the lowest returns and vice-versa.
Despite some regional variations, the low volatility anomaly was essentially not observed over the two-year period under consideration.
Conventional logic suggests that lower volatility companies offer a safer investment option when risk and volatility are rising, and they have traditionally been a haven for those seeking defensive positions in times of economic stress.
2. We looked at the Sharpe Ratio, which measures risk-adjusted returns
StarMine research has previously found that a lower volatility portfolio has the highest risk-adjusted returns, as measured by the Sharpe Ratio.
During the period of this latest research, the ratio showed a tendency to decrease alongside rising volatility – in other words, an inverse relationship with volatility was evident.
This means – on a risk-adjusted basis – that the lowest volatility equities performed better than the highest volatility ones.
Stock return and Sharpe Ratio versus volatility quintile
Our primary conclusion is that, in a period of economic crisis such as the COVID-19 pandemic, a low volatility strategy should be avoided, but on a risk-adjusted basis, low volatility portfolios still present a better performance than those with the highest volatility.
Why was the impact of COVID-19 on equities anomalous?
COVID-19 catapulted the world into a period of unprecedented uncertainty, one which has challenged traditional wisdom and created anomalies in many areas of life.
The unique nature of this global crisis had – and continues to have – a plethora of ripple effects, including those impacting stock returns.
With the advent of COVID-19 many traditional business activities, almost overnight, ground to a halt as borders closed, curfews were introduced and entire societies were instructed to stay at home.
In this highly unusual environment, attention almost immediately turned to companies able to operate with no physical presence, including technology-driven companies and many that were previously viewed as more volatile.
Suddenly, the ability to operate in the cloud, for example, became a tool for survival.
As the popularity of such companies rose, so too did their stock prices, creating this unusual, crisis-driven finding: more volatile stocks were delivering higher returns.
Helping investment teams achieve alpha
As the data revolution continues apace, the ever-increasing volumes of available data in financial markets can be unlocked to generate usable insights such as those we’ve discussed above.
These insights offer practical help to investment teams, helping them achieve alpha in a competitive marketplace.
Data can power superior investment decisions, but it requires the right expertise to unlock its value, spot trends, identify patterns and deliver insights.
StarMine, Refinitiv’s quantitative analytics and financial modelling suite, has been designed to help investors in exactly this way – by extracting usable value from the treasure trove of data available in today’s market.
With a 20-year track record, StarMine is underpinned by a deep pool of global expertise. Our dedicated team of specialists conducts rigorous, ongoing analysis and distils their findings into tangible insights that help you make smarter decisions and achieve optimal returns.