Emma Wall: Hello, and welcome to the Morningstar European Investment Conference. I am Emma Wall and I am joined by Roger Ibbotson, Professor at the Yale School of Management to talk about popularity, risk and returns in this stock market. Hello, Roger.
Roger Ibbotson: How do you do?
Wall: So, portfolio theory suggests that higher risk equals higher return, however, I know that you've done some research, which suggests over time, low beta, low volatility stocks have actually outperformed high volatility stocks, is that right?
Ibbotson: That is right. Higher risk and higher returns are associated across markets and in the bond market, but surprisingly in the equity market it's not the case, low beta, low volatility in all kinds of different contexts actually have higher returns. Higher returns and lower risk.
Wall: So, what's driving these returns then? If risk isn't a way to help investors gauge what's going to outperform next? What can we use?
Ibbotson: Actually what I'm saying it is, is popularity. There are types of characteristics that are unpopular, have higher returns. Usually risk is unpopular, so usually that's associated with higher returns, but there can be contexts where risk is actually popular and it's always going to be the less popular that has the higher returns.
Wall: Actually, one example I suppose of that is emerging markets pre-recession, they were very expensive and they are pretty risky.
Ibbotson: Yeah, they were, but people get excited about them, they had a good run of returns before that and then they – people buy, I guess, they buy them when they were on the news a lot and when they are in the news a lot, they are overpriced and the time to buy them is actually when they are out of favor, so the idea here is, you buy things that are out of favor, they will be temporary mispricings, there are certain kinds of characteristics all that are always unpopular, such things as basically small caps, they are unpopular, because who wants buy a small cap when you spend so much time looking for the company and they can't – if you are an institution, you can't put much money into it.
Who wants to buy a value stock? Have you seen the – those companies are not good companies, they might be good stocks, but good stocks and good companies are not necessarily the same. It's easier for a good company to go bad, to get worse and a bad company – it's much easier for a bad company to improve.
Wall: It's contrarian investing then?
Ibbotson: It is contrarian investing, perhaps by another name here, but it is contrarian investing, so yes, it's the same thing, it's been around for long time, it's just being – now we actually apply to even premiums in the market, not just mispricing.
Wall: So then, look, using your theory, where should investors be putting their money now?
Ibbotson: You wanted to buy what's unpopular. I guess, sort of an extreme example might be Russia. At this conference, we've been talking about – we had somebody talk about how terrible the situation in Russia is. They are – what it means is that those stocks in Russia are really at bargain-basement prices right now. You have to buy them really when nobody else wants them. It's not guarantee to work, but if you could do this over a lot of different scenarios and a lot of different markets, on average, you are going to get better returns when you buy the unpopular stocks.
Wall: I think you said in your talk, maybe don't show people what's in the portfolio, you just show them the returns.
Ibbotson: Well, yes, you actually look at the stocks in unpopular stocks. Usually, there is something wrong with those companies, they may have bad management, they may just had a string of bad events that happened to them, but it's easier to improve bad management than it is to improve great management. If great management tend to get worse over time, bad management tends to improve, but the markets don't seem to realise that. So buying what's unpopular actually has very good returning characteristics. One of the nice things about this is, something is always unpopular at all time. It doesn't go away when we discover this.
Wall: Roger, thank you very much.
Ibbotson: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
