Why Does Low Risk Investing Work So Well?

Beat the market and minimize risk? Yep, it's possible

The best investing book I’ve read in the past few years has been Low Risk Rules by friend of the newsletter Geoff Saab.

The book bills itself as a wealth preservation manifesto, and it emphatically delivers. Saab explains how a conservative, simple plan beats a lot of different options, and why it’s a terrific choice for folks who want to make sure they don’t screw up a windfall.

I think it’s a terrific book for people who aren’t quite wealthy yet, too. It outlines how low risk investing can actually beat the market over time, all while minimizing drawdowns during turbulent markets.

In short, it’s pretty much a roadmap of how to get rich slowly while minimizing the potential to do something regretful during a market correction. It naturally results in a portfolio stuffed with conservative, dividend-paying stocks. That’s pretty much what we preach around here, so no wonder I’m such a big fan.

Let’s take a closer look at how it works, how I use a low risk approach to build my portfolio, and a few boring stocks your author thinks would look great in a low risk portfolio.

First, what’s low risk investing?

Risk is largely measured by volatility. 

(Yes, I realize Charlie Munger said that was a dumb way to measure it, but screw it. We’re going with it)

The thinking goes something like this. If a stock tends to go up faster than the overall stock market during good times and down faster than the market when it falls, then that stock would be considered risky.

Risk is measured by a unit called beta. Beta measures volatility versus the overall stock market and assigns each stock a value. A stock with a beta higher than 1 is more risky than the overall market and a stock with a beta under 1 is less risky than the overall market.

Most market information services will track beta for you. Here’s a screenshot from Tikr, which I use almost exclusively to quickly get up to speed on stocks.

This is a screenshot of just some of the information on one of my favourite low volatility stocks, Rogers Sugar (TSX:RSI). Rogers Sugar has a beta of 0.58, indicating it’s about 60% as risky as the overall stock market — so really not that risky at all.

Despite Rogers not really delivering much in capital gains over the last decade — higher interest rates have hit the stock pretty hard over the last year, which hurt long-term returns — it has still delivered solid returns if you reinvested the company’s generous dividend.

Rogers is an excellent example of low risk investing. It delivers a product that both consumers and manufacturers use in pretty consistent volumes no matter what’s happening with the underlying economy. That produces steady earnings and predictable dividends.

An example of a high risk stock would be Shopify (TSX:SHOP), which has grown to become the largest tech company in Canada. It has a beta of 2.27, meaning if the market fell by 1% you’d expect the stock to be down 2.27%. The opposite would happen if the market was up 1%, of course.

How a low risk approach outperforms

It doesn’t really seem possible, but a low risk investing approach has been proven to beat global markets over the long-term. 

From a 2015 research report by Alliance Bernstein:

Since 1973, the least volatile quintile of global stocks delivered returns that were one-third higher than the market, with 20% less volatility. This performance generated a more than 50% higher Sharpe ratio—or absolute return relative to risk.

This was a 2015 report, so some might question whether the strategy has outperformed lately.

But that’s the wrong question to ask, since by design a low risk approach isn’t really designed to outperform during bull markets — and most of the last 10 years has been a relentless bull market.

It’s during bear markets where such an approach really shines. From the same report, which nicely demonstrates how much a low risk strategy outperforms during downturns:

There has been a clear outperformance by a low risk investing strategy during every significant bear market during the last 50 years — except, interestingly, the 1987 and 2020 market crashes.

That performance has continued through 2023, too. MFS investment research put out a report in March that showed that low volatility stocks have delivered a 12%+ average annual return from 1971 through 2023, compared to the S&P 500’s average annual return of approximately 10% — and with less volatility, too.

I’ve long realized I don’t want huge swings in my portfolio, so I embraced a low volatility strategy without really realizing it. I took a look at my portfolio goals (generate lots of dependable dividends and don’t blow up during bear markets) and built my portfolio accordingly.

And naturally what happened was I ended up with a boring set of assets that tended to slightly underperform during bull markets and hold up pretty well during bear markets. I embraced this very strategy somewhat by accident.

This outperformance during bear markets is the whole reason the strategy works. It also works because less volatile companies tend to be mature, stable companies with solid balance sheets, predictable earnings, and strong cash flows. These are where investors go to hide during bear markets.

These stocks are also often underpriced compared to their higher growth counterparts, meaning it’s much easier for investors to buy them at a discount.

Combine it all together and it’s one of those ridiculously simple ideas that can really change someone’s future.

How Canadian investors can embrace a low risk strategy

Let’s look at two simple ways Canadian investors can add a low risk strategy to their portfolio.

The easiest way is via an ETF. There are a few different choices that Canadian investors can go for if they’re looking for local stocks that trade on the Toronto Stock Exchange.

The BMO Low Volatility Canadian Equity ETF (TSX:ZLB) is the largest and most liquid low volatility ETF in Canada with some $3.5B in net assets under management. It has a 0.35% management fee and has turned a $10,000 investment into more than $25,000 over the last decade — assuming reinvested dividends. That works out an almost 10% average annual return, beating the TSX Composite index pretty significantly.

The fund has 49 different holdings. Here’s a snapshot of the top 10:

You’ll notice a lot of boring companies in the top 10, and that’s no accident. Sectors like consumer staples and utilities are well-known for their defensive properties. They’re notoriously low beta. There are some financials there too, but interestingly not Canada’s largest banks — which all have a beta close to 1.

You can also easily build your own low volatility portfolio. The premium edition of this newsletter researches a ton of low risk Canadian stocks and I show you my portfolio — which is stuffed with those kinds of names, including many in the list above.

Just $150 per year. Upgrade today!

Here are a few low volatility stock ideas to get you started:

Rogers Communications (TSX:RCI.B) is Canada’s largest wireless telecom provider, and it just got much bigger on the wireline side by acquiring Shaw Communications. Analysts predict the company will increase the bottom line by 20%+ in both 2024 and 2025 as it pays down debt and creates further synergies, yet it trades at approximately 10× 2024’s earnings estimates. The stock is cheap.

It has a beta of 0.54 and pays a 3.8% dividend.

Automotive Properties REIT (TSX:APR.un) hasn’t been this cheap since 2020. It’s Canada’s premier owner of car dealership property with 77 income producing properties spanning 2.9M square feet of gross leasable area. 80% of its portfolio is located in Canada’s six largest metros.

APR is a slow grower with earnings growing by 2-3% per year on a per share basis, but the stock is trading at an attractive valuation of 10x funds from operations. It also offers a succulent 8.2% dividend yield, with a payout ratio of approximately 85%. Considering the predictable nature of the company’s revenues, the distribution looks to be pretty secure even with the high payout ratio.

The stock has a beta of 0.87.

Finally, we’ll take a closer look at Corby Spirit and Wine (TSX:CSW.A)(TSX:CSW.B), the owner of leading spirit brands in Canada like Absolut, Jameson, Polar Ice, and J.P. Wisers. Corby has also been expanding into ready-to-drink beverages with the Cottage Springs line, and it just acquired the Nude ready-to-drink brand in Western Canada.

After struggling to grow the top and bottom lines for years, Corby is finally back into growth mode. The top line grew by 23% in its most recent quarter, and I predict adjusted earnings per share in the $1.20 per share range for this year, an increase of approximately 6%.

Corby is 51% owned by French spirits giant Pernod Ricard, and has exclusive rights to market the parent’s products in Canada. With the stock trading at just 11x earnings and paying a 7% dividend, there’s always the chance the parent throws up its hands and takes it private, which potentially gives the stock a catalyst.

Corby has a miniscule 0.26 beta, a result of both the company’s boring nature and its small cap status. It has a market cap of just $370M and often only trades a few thousand shares per day.

The bottom line

Low risk investing is a wonderful investing concept that works because it delivers solid gains during bull markets and protects your capital during market meltdowns. It also captures some of the value factor since low risk stocks rarely get that expensive.

Unfortunately, in a world where even the largest tech stocks can increase 10% (or decline 10%) in an after-hours trading session based on just one quarter’s earnings, low risk investing looks like an outdated concept that’ll never work in today’s go-go world.

I couldn’t disagree more. Getting rich quickly might seem like the easy solution, but swinging for the fences has consequence. It’s better to embrace a get rich slowly approach — one that’ll generate gains in good times but, most importantly, help protect your money during bad times.

Low risk investing works, plain and simple. It’s a powerful investing concept that most anyone can use effectively, either via ETFs or choosing your own stocks. Embracing it really made a difference for me. Maybe it’ll do the same for you.