Active vs passive low risk investing

The scientific foundations for low volatility investing were laid almost 70 years ago and are well understood, but investors are increasingly focusing their attention on issues of practical implementation. A key concern for investors is how to incorporate ESG and liquidity preferences into low risk portfolios while managing transaction costs optimally.

The occurrence of negative oil prices during the Covid-19 crisis and consequent effects on passive oil ETFs have raised additional questions about passive investment vehicles: managers had to actively intervene to override passive rebalancing rules to mitigate the risk of the vehicle’s failure.

In this paper, we examine and highlight the strengths of active low risk investing compared to passive low risk investing. We find that passive low risk indices have significantly larger illiquid holdings than active low risk portfolios and we demonstrate the adverse effects of such concentration risk in stress situations. Moreover, an examination of ESG characteristics shows that existing passive indices provide suboptimal carbon and ESG characteristics compared to what active management can offer.

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