Normally, higher risk leads to higher expected returns – that does not apply for stocks
It is a generally accepted presumption that a positive relationship exists between risk and expected return. A rational investor would only buy a risky asset class if he anticipated getting compensated for the higher risk by receiving a higher return. Bonds of high creditworthiness therefore have lower expected returns than, for instance, junk bonds or equities.
Within equities, however, this relationship does not hold true. Academic studies suggest that in the long term, stocks with the lowest risk outperform stocks with the highest risk. In the US equity universe the 20% stocks with the lowest volatility outperformed the 20% stocks with the highest volatility by 7% annually over the course of 40 years until 2008. The study covering a global equities universe is about 20 years shorter, but comes to a very similar conclusion.
Defensive equity investing added value in the US…
Empirical evidence (1968-2008)
Average annual outperformance for US equity universe