A Multifactor Perspective on Volatility Managed Portfolios 

Authors: Alberto Martin-Utrera, Raman Uppal and Victor DeMiguel

 

Abstract: A fundamental insight in finance is that there is a strong risk-return tradeoff. Moreira and Muir (2017) challenge this by showing that investors can increase Sharpe ratios by reducing exposure to risk factors when their volatility is high. However, Cederburg, O'Doherty, Wang, and Yan (2020) show these strategies fail out of sample and Barroso and Detzel (2020) show they do not survive transaction costs. We propose a novel conditional multifactor portfolio whose weights on each factor change with market volatility and outperforms its unconditional counterpart even out of sample and net of costs, and during both low- and high-sentiment periods. Our results demonstrate that the breakdown of the risk-return tradeoff is even more puzzling than previously thought.