Low Volatility Investing Glossary: Key Terms Defined

These short definitions cover vocabulary that appears throughout the low volatility literature.

Risk measures

Volatility: how much a stock’s return varies over a period. High volatility means the price can move sharply either way in a short time; low volatility means it changes more gradually.
Standard deviation: a statistical gauge of how spread out a set of results is. For a stock it indicates how volatile, and so how risky, the shares have been.
Beta: sensitivity to the market. A beta of one implies that when the market rises by one per cent, the stock is expected to rise by about one per cent too.
VIX: the Volatility Index, often called the fear index, which reflects the market’s view of how risky conditions are at a given time.

Alpha: the return in excess of what the stock’s market risk (beta) would predict, i.e. its risk-adjusted excess return (Jensen’s alpha), rather than the simple difference from the market’s return.
Sharpe ratio: a risk-adjusted measure showing whether returns came from skill or merely from taking extra risk.
Risk-adjusted return: a portfolio’s return reduced to reflect the risk it carried.

Capital Asset Pricing Model (CAPM): a modern finance model linking risk and expected return on the assumption that markets are efficient. Haugen’s research disputed it by finding that low-risk stocks beat high-risk ones over time.
Efficient market hypothesis: the theory that prices always reflect fair value, so beating the market by picking stocks or timing is impossible and higher returns come only from taking higher risk.
Agency issues: conflicts of interest among investment managers, and between them and their clients. In Haugen’s view, managers pitch stocks with a strong story; these attract heavy media and analyst attention, which raises volatility and pushes investors towards more volatile holdings.

Capitalisation-weighted portfolio: holds more of larger companies than smaller ones.
Equal-weighted portfolio: puts the same amount into every stock.
Decile: a ten per cent slice of a ranked list of stocks.
Quintile: a twenty per cent slice.

Terms such as these are explained further in the research summaries.