All about low volatility investing 101

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Here is the low-down on this index. As the name suggests, the index selects 30 securities from within the NIFTY companies based on their volatility. In a nutshell, here is how the stock selection is done. Firstly, all the stocks in the NIFTY index with a minimum listing history of 1 year are selected.

Next, all the selected stocks are ranked on the basis of their volatility score. Volatility, in this case, is calculated as the standard deviation of the daily price returns of the last year. Standard deviation measures how widely prices of a stock are dispersed from its average price. So, the higher the standard deviation of any security, the higher its volatility. After the calculation of volatility, the top 30 stocks are selected on the basis of their inverse volatility.

This means stocks with the lowest volatility get the highest weight in this index and the weights reduce as the stocks keep getting more volatile. The index is rebalanced on a quarterly basis. Several low-volatility strategies have existed for more than 10 years. Most academic studies and most low-volatility indices are based on simulations. Some studies go back 90 years and show that low-volatility stocks beat high-volatility stocks over the very long run see image.

Since low-volatility securities tend to lag during bull markets and tend to reduce losses in bear markets, a full business cycle is needed to assess performance. Over a shorter time period like one year, Jensen's alpha is useful to calculate performance. This performance metric corrects the performance of for market beta risk. For example, when a low-volatility strategy has a beta of 0.