Stock markets are as calm as they've been in five decades, causing investors to crowd into funds that aim to minimize volatility. Goldman Sachs is questioning whether that is the right goal in such a calm market.
"Fund managers should seek to maximize prospective risk-adjusted returns rather than minimize realized volatility," said Goldman Sachs' chief U.S. equity strategist, David Kostin.
Put simply, investors are focusing too much on finding stocks that offer just low volatility and not enough on stocks that offer both low volatility and high returns.
Kostin has updated the bank's list of stocks that can maximize returns in a low-volatility market, removing tech giants Facebook and Alphabet and adding stocks including Autozone, Discover Financial Services, Dollar Tree, HP Inc. and Intel.
A widely watched number called the VIX, which is an options-based measure of how much it would cost to protect a stock portfolio from a market decline in the near future, remains near record lows. The S&P 500 volatility in the last six months ranked in the first percentile going back as far as 1966, according to Friday's research note. And the numbers looking ahead one month to five years suggest that the VIX will stay below its historical average, the bank said.
Investors looking to maximize returns should focus on stocks that have a high Sharpe ratio, a calculation that compares the performance of a stock to the return on a relatively risk-free investment such as a government bond. It helps an investor judge whether the return on the stock is greater than the additional risk taken to generate that return.
Goldman's list is a rundown of stocks that generate high Sharpe ratios. It makes a new list every six months. So far this year, stocks on the list have outperformed the S&P 500 by 12 percent versus 10 percent, Goldman said, and since 1999 the strategy has beaten the S&P 500 in the semi-annual periods 71 percent of the time.
Shares of Autozone and Discover Financial have declined year to date but each has a Sharpe ratio of 1.0 or more, a threshold that is generally seen as a good indicator. Shares of Anadarko Petroleum, which is also mentioned, have sold off this year, but have a ratio of expected return to implied volatility of 2.1, the highest on Goldman's list.
Goldman said the median stock on its new list had three times the expected risk-adjusted return of the median S&P 500 stock. The firm said consensus expects 21 percent upside for this group of stocks versus 6 percent for the median S&P 500 stock.
For more on Goldman Sachs, watch CEO Lloyd Blankfein's interview on Mad Money tonight at 6 p.m. ET.
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