What are we looking for?
Low-volatility names for investors who think the Canadian equity market might continue to slide.
The screen
The dismal results are in. Unfortunately, after a fairly volatile year, the S&P/TSX Composite Index has posted a loss of 8.3 per cent, a figure close to 2011, when the index was down 8.7 per cent. For those who think this may continue into 2019, the followings strategy might offer some lower-volatility ideas. To find these names, I first ranked the largest 250 TSX-listed stocks (by market capitalization) across the following metrics:
- Five- and 10-year deviation of earnings (a statistical measure showing how volatile a company’s earnings have been, lower figures preferred);
- 90- and 180-day standard deviation of returns (a volatility measure against total return, lower figures preferred);
- Dividend yield.
To qualify, a stock must have a debt-to-equity (D/E) ratio similar or lower than that of the sector to which it belongs (in the accompanying table, a figure of 0.9, for example, means that the D/E ratio is 10-per-cent lower than the sector’s median). Additionally, the stock must pay a dividend.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 120 equity and credit analysts, Morningstar has one of the largest independent institutional equity-research teams in the world.
What we found
I used Morningstar CPMS to back test this strategy from January, 1999, to November, 2018. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four per economic sector. Once a month, stocks were sold if their rank fell below the top 25 per cent of the ranked universe, or if consensus earnings-per-share estimates dropped by more than 10 per cent over three months. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 10.4 per cent while the S&P/TSX Composite Total Return Index produced 6.8 per cent. The portfolio beta measured over this time period was 0.3; recall that in trending markets, a portfolio with beta less than one has historically moved less than the market, a desirable characteristics in bear markets.
The stocks that meet my requirements and they are listed in the table below. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
Ian Tam, CFA