With multifactor investing gaining traction in recent years, investors now have 440 multifactor ETFs and index mutual funds with a total of $74 billion in assets¹ to choose from.

The investing community has largely accepted and focused on five primary factors—size, value, quality, momentum and low volatility—which serve as the bedrock of multifactor funds to varying degrees. When WisdomTree was researching its U.S. and global multifactor strategies, we wanted to include elements of these five as well.

However, we wanted to differentiate our approach by seeking a diversified set of alpha drivers focused on concentrated stock selection rules and portfolios with meaningful factor tilts. Investors have plenty of benchmark-hugging, low-tilt, low-tracking-error funds at their disposal. Our latest multifactor approach was designed to lean into and pursue high value-added stock selection while trying to balance the risks that come with more concentrated portfolios.

Of the single-factor strategies that have resonated with investors, low volatility stands out. WisdomTree did not include low volatility as an alpha-seeking pure stock selection factor in our methodology. There are ultimately two reasons why.

Reason One: Risk-Adjusted Returns Are Not Absolute Returns

The first reason we don’t include low volatility as an alpha component is because over long periods, low-volatility stocks have not consistently outperformed the market. Low-volatility stocks have historically outperformed high-volatility stocks over time and have delivered lower risk than the overall market. But the absolute excess performance of these stocks versus the market has historically been spotty.

This has held true over the last 50-plus years. Using the data from Professor Kenneth French’s database, the least volatile 20% of large-cap stocks have underperformed the market since 1963 by 0.6% per year. While low-volatility stocks have outperformed the most volatile stocks and had a higher Sharpe ratio than the market, the magnitude of their underperformance—compounded over such a large time frame—is hard to ignore.