Unconventional wisdom: Is this strategy the antidote to overvalued markets?
This rebel economist thinks academics and professional investors have the market all wrong.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Is this strategy the antidote to overvalued markets?
“Although efficient markets people still go around saying there is a “mountain” of evidence supporting their hypothesis, the truth of the matter is that it’s a very old mountain that’s now eroding rapidly into the sea.”
- Bob Haugen
After a little more than two months 2026 is shaping up to be the year when investors embrace ‘boring’.
There is nothing boring about what is happening in the world as the news cycle shifts from the AI job apocalypse to war to trade disputes. But in the face of all this change boring investments are outperforming.
There is no official definition for a ‘boring’ investment but as a proxy we can use volatility. Shares with wild price swings are certainly not boring. Lower volatility fits the bill.
The following chart shows year-to-date S&P 500 performance by sector and the standard deviation. Standard deviation is one measure of volatility which shows the dispersion of returns around the average return. The higher the standard deviation the more volatility an investment is exhibiting. The S&P 500 data in the following chart is through 4 March.
Most of the top performers fall on the lower volatility side of the 11 S&P sectors. Energy is an obvious outlier that has recently been impacted by the Iran war.
This is a very small sample size. The larger question is, are boring investments preferable over the long-term? One man thought they were.
The enfant terrible of the Ivory Tower
Central to investing theory is the exchange of risk for reward. The more risk you take in terms of volatility the more reward you receive in the form of higher returns. Shares are more volatile than bonds and historically their returns have been higher.
In theory this doesn’t just occur between asset classes but also within asset classes. More volatile shares should have higher long-term returns than less volatile shares. The capital asset pricing model (“CAPM”) is the cornerstone of modern financial theory. CAPM puts this concept into a formula using beta as the measure of volatility.
Beta is a measure of an investment’s volatility or sensitivity to market movements relative to a benchmark. The benchmark beta is 1 with a beta greater than 1 indicating more volatility than the benchmark, while a beta below 1 equates to less volatility. According to CAPM high beta shares should have higher returns over the long-term.
Bob Haugen thought all of this was nonsense. In one posthumous tribute Haugen was referred to as “enfant terrible of the Ivory Tower, a rebel economist with a cause.” This seems a bit much but the cause that Haugen dedicated his career to was the notion that low volatility shares offered higher returns than high volatility shares. In other words, boring is better.
Bob Haugen wasn’t the average punter. He was a professor at the University of Wisconsin, the University of Illinois and the University of California. He also started a quantitative investment manager called Haugen Custom Financial System.
Haugen passed away in 2013, but his research has widespread implications for how investors should approach the market – now more than ever.
In 2012 Nardin Baker and Robert Haugen collaborated on a paper called Low Risk Stocks Outperform within All Observable Markets of the World. The paper covered share market returns between 1990 and 2011 in 21 developed countries and 12 emerging markets. Each month shares were ranked by volatility over the previous 24 months and placed into deciles. They examined the returns for each volatility decile.
The results are remarkably consistent. In every single country the lowest volatility decile outperformed the highest volatility decile over rolling 3 year returns except for two periods – the height of the dotcom bubble and right before the global financial crisis.
Source Low Risk Stocks Outperform within All Observable Markets of the World: Baker & Haugen
Haugen had an explanation for this anomaly. His research showed that financial institutions have greater exposure to volatile shares, analyst coverage is higher on more volatile shares, and the news media covers them more. As a result, they are overvalued. He found data supporting each of these assertions.
If high volatility shares were in more portfolios but low volatility shares offer better returns there is a problem. It means that investors in market capitalisation weighted index funds are taking the wrong approach. Chasing the hottest shares leads to subpar outcomes as investors are trapped in high-priced stocks with lower expected returns.
Haugen hated market capitalisation indexes. He believed there is a negative relationship between volatility and returns in the share market. Index funds didn’t capture this anomaly.
Should you follow this strategy?
Haugen was a true believer but most academics and investment professionals think he is wrong. He had little time or patience for criticism and thought his critics had a “vested interest” to reject evidence contrary to their view. Haugen called existing finance textbooks “dramatically wrong” and called for them to be rewritten.
It isn’t an exaggeration to suggest Haugen thought there was a conspiracy theory perpetrated by academics and investment professionals placing their interests above investors.
The difficulty in assessing Haugen’s view and those of his critics is the challenge of isolating individual factors that influence security prices. Correlation and causation are not the same thing. There is also the inconvenient truth that since his last study came out in 2012 his strategy has not worked.
The following chart shows the performance of different volatility strategies using the S&P 500 index. The low volatility strategy has meaningfully underperformed.
The market goes through different cycles and in the last decade the US has been on a historic bull run. This is also an environment when passive investing has become more popular which may be impacting markets – that is a topic I covered in a previous article.
This has not always been the case. The first decade of this millennium is illustrative. The S&P 500 went nowhere in the 2000s which has become known as the lost decade. The market capitalisation weighted S&P 500 had an annual return of -0.99% a year between 31 March 2000 to 31 March 2010. An equal weighted S&P 500 index returned 5.44% a year.
Even in a lost decade most shares went up. It was the highly concentrated market in early 2000 that failed to deliver.
This outperformance persisted. The S&P 500 equal weighted index outperformed the market capitalisation weighted index by 1.50% a year from the dotcom bubble through 2022.
What has influenced the returns in the previous chart has been the AI run up post 2022. The tech giants have driven returns and like the dotcom bubble the market is highly concentrated. That is why Haugen is back in vogue.
What about Australia?
The data available on the Australian market is less robust but I’ve gone through Morningstar’s coverage universe in Australia and New Zealand and identified the deciles with the lowest volatility and the highest volatility.
I used the 5-year beta as the volatility measure and the annual return over the last five years. First the low beta shares:
The high beta shares:
The average return of the low beta shares slightly exceeded the average of the high beta shares at 3.15% vs 2.71%. Both trailed the ASX 200 return of 5.90%.
Final thoughts
No investment strategy will work all the time. Sticking to a strategy that you have conviction in means weathering periodic underperformance. Sometimes those periods last a long time.
However, it is obvious what doesn’t work. Attempting to constantly switch strategies and read the tea leaves of an unknowable future will lead to poor outcomes.
Find a strategy that aligns with what you are trying to accomplish and one you have conviction in. Weathering periodic underperformance and staying disciplined will pay off in the end.
Do you think about Bob Haugen’s approach. Let me know at mark.lamonica1@morningstar.com
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What I’ve been eating
I was in Hobart for the weekend and in addition to hitting my favourite spots I tried something new. I’m glad I did. Omotenashi is a ten-seat kaiseki counter located in a Lexus dealership. A strange setting but the food and experience were amazing.
Pictured is sabazushi. Originally from Kyoto, sabazushi is salt cured mackerel marinated in vinegar. The curing technique was used to transport the mackerel from Fukui on the coast to landlocked Kyoto. This technique is perfect for mackerel as curing the fish removes oiliness and odor. Whatever they did to this version of sabazushi it turned out perfect.
