What are we looking for?
Low volatility amongst Canada's mid-cap names.
The screen
Due to the segmented nature of Canada's equity market, it is difficult to find stocks outside of the S&P/TSX 60 that can be used to create a reasonable portfolio with a focus on minimizing volatility. Given the recent market movements, I thought it would be appropriate to create such a strategy. Using Morningstar CPMS, I've ranked Canadian mid-caps based on the following factors:
- Earnings variability (a measure that looks at the full history of each company’s reported earnings and tracks how consistent they are over time – lower scores are preferred);
- Three-hundred-day standard deviation of returns (another measure of volatility, but looking only at the stock’s daily price movement – lower deviations preferred);
- Five-year price beta (a measure of a stock’s price movement relative to an underlying index. A beta less than one indicates that, in historically trending markets, the stock’s price will move less than the index);
- Five-year standard deviation of return on equity (which measures how volatile a company’s profitability is over the past five years) – lower deviations preferred.
To qualify, stocks must have a market cap of less than $2-billion and a monthly trading volume greater than $9-million. In addition, the company's debt-to-equity ratio must be less than the sector median. (In the table, all the stocks have a ratio of less than 1.0, meaning they are less leveraged than the median of the sector to which they belong.)
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used CPMS to back-test the strategy from January, 1999, to December, 2015. During this process, 15 stocks were purchased and equally weighted with a maximum of four stocks per sector. Stocks would be sold if they fell outside the top 50 per cent of the ranked. Over this period, the strategy produced an annualized total return of 12 per cent while the S&P/TSX composite total return index produced 6.5 per cent. Despite the market volatility in 2015, this same strategy produced 3.6 per cent while the composite fell by 8.3 per cent. Today, 12 stocks qualify for purchase into the strategy and are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.