- Goldman Sachs recommends investors look for stocks with high Sharpe ratios in an environment with historically low volatility.
- The Sharpe ratio is calculated by dividing a stock’s future price target by its six-month implied volatility.
- The firm maintains a proprietary basket of stocks with high Sharpe ratios; it is tilted at the industry level toward semiconductors, pharma and biotech, capital goods, and insurance.
Sometimes, when the market isn’t moving enough to whip up returns, you have to take matters into your own hands.
That’s the crux of a recent recommendation made by Goldman Sachs, which has been strategising ways to profit from a stock market that has been stuck at a standstill for most of 2017, with the CBOE Volatility Index, or VIX, sitting close to the lowest levels on record.
The key, according to Goldman, is to identify companies with a high Sharpe ratio – a measure calculated by dividing a stock’s future price target by its six-month implied volatility. In doing so, traders are then presented with stocks set to provide the best risk-adjusted return on investment. These types of companies tend to outperform in a low-volatility environment, the firm says.
Goldman has constructed a basket of stocks with lofty Sharpe ratios that it says is a much better bet than simply making trades set to profit from subdued price swings. The firm notes that when six-month realised volatility has been less than 12, its proprietary index has beaten a minimum-volatility strategy 73% of the time since 1999.
As of right now, Goldman’s newly rebalanced 39-company basket is tilted at the industry level toward semiconductors, pharma and biotech, capital goods, and insurance. The firm says that, relative to the median S&P 500 stock, its basket offers triple the expected return at a similar level of expected volatility.
Here’s a sampling of the companies in Goldman’s index:
- Consumer discretionary – Dish Network, Expedia
- Consumer staples – Molson Coors, CVS Health
- Energy – Range Resources, EQT
- Financials – Assurant, XL Group
- Healthcare – Alexion Pharmaceuticals, Incyte
- Industrials – General Dynamics, General Electric
- Tech – Western Digital, Xerox
- Materials – Ball Corp., Newmont Mining
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